COMMISSION STAFF WORKING DOCUMENT Analysis of the Euro Area economy Accompanying the document Recommendation for a Council Recommendation on the economic policy of the Euro Area
Date: 2019-12-17
Institutions: Directorate-General for Economic and Financial Affairs, European Commission
Subjects: EU banking union, economic growth, economic reform, education policy, employment policy, euro area, investment policy, labour market, structural adjustment, vocational training

EN 

  EN 

   EUROPEAN COMMISSION  Strasbourg, 17.12.2019  SWD(2019) 631 final  COMMISSION STAFF WORKING DOCUMENT Analysis of the Euro Area economy Accompanying the document Recommendation for a Council Recommendation on the economic policy of the Euro Area {COM(2019) 652 final}  
 
 
Executive summary 

The  euro  area  is  continuing  its  expansion,  though  growth  is  moderating  and 
interconnected  risks  to  the  outlook  have  increased  along  with  uncertainty.  Risks  to  the 
outlook and uncertainty have heightened, notably given trade risks which are also contributing 
to the growth slowdown. The euro area’s current account surplus is projected to narrow but 
remains sizeable and country divergences continue to be significant. Real convergence among 
euro  area  countries  appears  to  be  resuming  slowly  with  rising  disposable  income  and 
declining poverty and social exclusion in virtually all Member States. However, the share of 
income held by the highest income levels has slowly increased in the past decade. The euro 
area  economy  is  facing  short-term  challenges  stemming  from  the  uncertain  outlook  and 
interconnected risk factors as well as long-term challenges stemming from the emerging risk 
of  a  prolonged  period  of  low  potential  growth  driven  by  anaemic  productivity,  and  aging 
populations. 

Decisions on the macroeconomic policy stance need to be taken against the background 
of  low  inflation  and  a  weakening  outlook  which  might  be  persistent.  The  ECB  is 
maintaining an accommodative monetary policy. The euro area fiscal stance is expected to be 
broadly neutral between 2019 and 2021 (see section 4). While the euro area debt to GDP ratio 
is  projected  to  continue  decreasing,  the  aggregate  deficit  is  expected  to  increase  from  the 
historical  low  recorded  in  2018,  mainly  due  to  the  impact  of  expansionary  discretionary 
measures  and  automatic  stabilisers,  which  more  than  offset  the  projected  decline  in  interest 
expenditure. Meanwhile, national fiscal policies are insufficiently differentiated according to 
available  fiscal  space.  A  key  question  in  a  downside  scenario  is  what  would  be  the  most 
effective fiscal response across member states taking into account the respective fiscal space 
and severity of the downturn. The aggregate fiscal policy stance might need to become more 
supportive should negative risks materialise. 

Acting  on  the  composition  of  fiscal  policy  represents  a  powerful  policy  lever.  Member 
States have been slow in improving the quality and composition of public finances. Improving 
Member  States’  public  investment  strategies  and  green  budgeting  analyses  are  essential  to 
support growth and face long-term challenges such as the climate transition and technological 
transformation.  Addressing  aggressive  tax  planning,  engaging  in  spending  reviews  and 
improving the functioning of fiscal frameworks at large would be essential measures for more 
growth friendly and greener fiscal policies.   

Structural reforms are needed to complement macroeconomic policies.  Reform progress 
remains  low  despite  efforts  to  improve  implementation  within  the  European  Semester,  and 
productivity growth in the euro area has been declining in line with what is happening across 
advanced  economies.  Structural  reforms  could  contribute  to  bridging  the  productivity  gap 
while strengthening institutional quality would be key in improving the delivery of structural 
reforms, namely on product and services market regulations where reform effort is slowing. 

Labour  market  indicators  continue  to  improve  but  challenges  in  terms  of  job  quality, 
and  skills,  as  well  as  labour  market  integration  of  under-represented  groups,  remain. 
Employment  figures  are  improving  but  the  materialisation  of  risks  can  negatively  impact 
labour market developments, especially for more vulnerable Member States and workers and 

1 

 
 
while wage growth accelerated, it is  unclear how far this dynamic will be sustained beyond 
the forecast horizon. In the long-term, technological change and the digital revolution can be 
expected to create new jobs, while destroying others, raising challenges in particular for less 
qualified workers and increasing the need for investment in skills. 

to  face  challenges  from 

Risk  reduction  in  the  banking  sector  broadly  continues  but  completing  the  financial 
union would be key to further strengthening the sector’s resilience.  Measures have been 
taken  to  strengthen  banks’  resilience  but  bank  competitiveness  is  still  an issue  as  the  sector 
continues 
the  economic  environment  and  business-model 
transformation.  Going  forward,  important  areas  for  financial  integration  remain  to  be 
completed,  notably  the  backstop  to  the  Single  Resolution  Fund  and  a  European  Deposit 
Insurance  Scheme.  The  share  of  non-bank  finance  in  the  euro  area’s  financial  system  has 
continued to grow as the Commission delivered on all of the actions announced in the Capital 
Markets  Union  action  plan.  However,  barriers  for  an  integrated  capital  market  remain, 
including regulatory, legal and tax divergences. 

Progress  remains  slow  in  deepening  the  EMU.  There  has  been  some  progress  on  the 
economic  union,  with  political  agreement  on  a  euro  area  budgetary  instrument  for 
convergence and competitiveness and on improving the ESM toolkit. However, there was no 
progress  towards  a  euro  area-wide  fiscal  stabilisation  function  or  on  euro  area  governance 
proposals. Stronger progress on the measures proposed in the Commission Communications 
of December 2017 and of June 2019 would result in better macroeconomic outcomes.  

This  Staff  Working  Document  provides  an  analytical  underpinning  for  the  Euro  Area 
Recommendation  which  outlines  an  overall  orientation  for  the  collective  challenges 
ahead,  focusing  on  the  years  2020  and  2021.  The  recommendation  is  adopted  at  the 
beginning of the European Semester, to precede and inform the package of country-specific 
recommendations  which  is  adopted  in  the  spring.  For  the  first  time  this  year,  the  SWD 
includes  an  overall  assessment  of  progress  in  implementing  the  euro  area  recommendation 
(see Box 3). Since the euro area recommendation for 2019 and 2020 was published last year, 
some progress was made on structural reforms for growth, competitiveness and productivity 
and  there  was  also  some  progress  in  implementing  financial  sector  reforms.  However, 
progress  remained  limited  on  the  other  recommendations,  namely  fiscal  reforms,  labour 
market reforms and deepening the Economic and Monetary Union. 

1. Macroeconomic context and developments  

The  euro  area  is  continuing  its  expansion,  though  growth  is  moderating  and 
interconnected risks to the outlook have increased along with uncertainty. The economy 
has  been  expanding  at  rates  above  potential,  also  as  a  result  of  the  dynamics  of  euro  area 
consumption and investment, and the positive output gap is expected to hover around ¼-½%  
of potential GDP in 2020-21 (Graphs 1 and 2). Though growth is being sustained, the forecast 
has been revised down to 1.1% for 2019 and 1.2% for both 2020 and 2021. The expansion is 
still supported by steady – though slower - domestic demand, with a contribution of private 

2 

 
 
 
consumption to growth of 0.8%, of GDP for 2019, 2020 and 2021.1 Nonetheless, uncertainty 
remains  elevated  further  as  the  outlook  is  subject  to  a  number  of  downside  risks,  some  of 
which  have  started  to  materialise,  such  as  the  impact  on  confidence  of  trade  tensions  and 
Brexit.  Though  headline  inflation  was  accelerating,  driven  mainly  by  energy  prices  and 
services  inflation,  it  is  now  projected  to  slow  to  around  1¼%  both  for  2019-21  down  from 
1.8%  in  2018.  Core  inflation  (excluding  energy  and  unprocessed  food  prices)  is  forecast  to 
remain even lower than previously expected from the 1-1½% range in 2018 to around 1½% in 
2019-20.  This  is  despite  the  fact  that  real  wages  per  employee  have  slowly  increased  – 
following  several  years  of  stagnation  –  at  some  1%  in  2018  and  2019.  Wage  growth  is 
nevertheless projected to slow again to around ¾% in 2020-21. 

Notwithstanding  the positive  output  gap,  potential  GDP  growth  is  set  to  remain  below 
pre-crisis levels over the forecast horizon. Potential GDP growth is projected at below 1½% 
for  2019-21,  significantly  below  its  pre-crisis  level  of  some  2  percent  (Graph  2).  Structural 
unemployment, as measured by the non-accelerating-wage rate of unemployment (NAWRU), 
has been declining since 2013 from 9.4% and is projected to reach 7.7% in 2021 but is still far 
above levels of best performers in the euro area, at around 4%. 

While  supporting  GDP  growth  and  the  climate  transition  requires  further  investment, 
the  uncertain  outlook  could  weigh  on  investment  growth,  which  is  still  in  a  recovery 
phase in the euro area (Graph 3). Given the EU’s commitments to reducing greenhouse gas 
emissions2,  increasing  the  use  of  renewable  energy  and  improving  energy  efficiency, 
substantial  investment  is  needed to  support GDP growth that remains reliant on  greenhouse 
gas  emissions3.  Supporting  potential  GDP  growth,  during  the  environmental  transition  and 
given  its  weak  levels,  will  require  further  investment.  Though  total  investment  growth  is 
forecast to spike up to 4.3% in 2019 from 2.3% in 2018, it is predicted to ebb to 2.0% in 2020 
and 1.9% in 2021. Public investment as a percentage of GDP also remains low – around ¼-½ 
percentage points below the 2007-08 level - and is recovering only slowly in certain Member 
States. Importantly, net public investment has declined significantly, turning zero or slightly 
negative  between  2013  and  2018,  and  is  projected  to  recover  only  slowly  to  around  ¼  of  a 
percentage  point  of  GDP  by  2020-21.  Overall,  private  investment  has  recovered  faster  than 
public investment and is forecast to reach pre-crisis levels (Graph 3) by 2019-20. Beyond the 
crowding-in effect of public investment, an essential factor for the private sector to participate 
in increasing potential growth is the financial sector and financial markets’ ability to finance 
investment, and the credibility of the institutional and policy framework. 

With  additional  significant  medium  and  long-term  factors  weighing  on  growth  and 
inflation  –  and  in  the  absence  of  policies  to  address  them  –  the  risk  of  a  prolonged 
secular  stagnation  in  the  euro  area  economy  is  emerging.  The  low  potential  growth  and 

1 All forecast figures in this document are from the European Commission Autumn 2019 forecast. 
2 European Council Conclusions, 24 October 2014, EUCO 169/14, 
https://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/145397.pdf  
3 NBER working paper 26167 “Long term macro effects of climate change Khan Mohades Ng Pesaran”, IPPC 

reports. 

3 

 
 
                                                 
productivity, low inflation, and rising inequality coupled with deteriorating demographics are 
a reminder of the Japanese economy since the early 1990s  (Box 1) and call for policy action. 

The slowdown in growth may also be attributed in part to the slowdown in trade, and 
further trade risks loom on the outlook.  For 2017 and 2018 each, net exports contributed 
nearly  ½  percentage  point  of  GDP  growth,  or  around  one  fifth  and  one  fourth  of  growth 
respectively.  This  contribution  is  expected  to  become  zero  or  negative  in  2019  and  2020. 
Given the EU’s position as a highly open economy with large export-dependent economies, 
the  evolution  of  trade  disputes  will  have  an  important  bearing  on  the  growth  projection. 
Empirical  analysis  suggests  that  a  substantial  increase  in  tariff  rates  on  US  imports  of  cars 
from the EU would have a significant and disruptive impact on economic activity4. FDI flows 
between  the  EU  and  the  rest  of  the  world  also  declined  in  2018.  In  this  context  of  failing 
multilateralism  and free  trade, it is  uncertain  whether the impact  of trade on growth  will be 
transitory or permanent. 

The euro area’s large current account surplus is projected to decrease in 2019 and 2020 
but  country  divergences  continue  to  be  significant  on  the  external  side.  The  euro  area 
current account surplus is forecast to narrow from some 3¾ % of GDP in 2018 to 3-3¼ % in 
2019-21.  At  country  level,  the  correction  of  large  deficits  is  not  matched  by  a  comparable 
adjustment of large surpluses, which are expected to decrease but to a smaller extent in some 
Member States. Those countries in a net creditor position therefore continue to increase their 
net  international  investment  positions  (NIIP).  Moreover,  the  reductions  in  current  account 
surpluses are explained by lower contributions of net exports to growth rather than an increase 
in  domestic  demand.  The  NIIP  to  GDP  ratios  of  the  most  indebted  Member  States  have 
improved  only  recently,  supported  by  improving  nominal  growth  and  external  surpluses, 
although sustained rebalancing efforts are still needed. Countries that recorded large deficits 
for  a  long  time  still  have  large  negative  NIIPs  that  represent  vulnerabilities,  and  are  often 
mirrored by large stocks of private and/or government debt. 

4 A CESifo study concluded that permanent US tariffs of 25% on German car exports would lower German car 
exports  to  the  US  by  almost  50%  and  total  German  car  exports  by  7.7%;  without  retaliation,  US  tariffs  are 
estimated to lower real incomes in the EU by 9  bn. EUR (0.06% of GDP) with the largest impact among the 
large Member States such as Germany (0.16% of GDP). See G. Felbermayer and M Steininger (2019). ‘Effects 
of new US auto tariffs on German exports, and on industry value added around the world’. Working Paper (ifo 
Institute),  February.  See  also  V.  Gunnella  (2019).  ‘Assessing  the  impact  of  the  threat  of  auto  tariffs  on  the 
global economy and the euro area’. ECB Economic Bulletin 3, pp. 59-61. 

4 

 
 
                                                 
 
Graph 1: GDP and its components, euro area 

pps. 

3
% of pot. GDP 

forecast 

Output gap (rhs)
Net exports
Inventories
Investment
Public consumption
Private consumption
GDP (y-o-y%)

2

1

0

-1

-2

-3

-4

10 11 12 13 14 15 16 17 18 19 20 21

3

2

1

0

-1

-2

-3

-4

Graph 2: Contributions to potential growth, euro 
area

2,0

1,5

1,0

0,5

0,0

-0,5

pps. 

forecast 

12

13

14

15

16

17

18

19

20

21

TFP
Capital accumulation
Changes in hours per empl
Labour (persons)
Potential GDP (y-o-y%)
Pre-crisis ('02-'07) (y-o-y%)

Graph 3: Public and private investment, euro area 

21

20

19

18

17

16

%GDP 

%GDP 

Private (lhs)
Private 95-09 average
Public (rhs)
Public 95-09 average

t
s
a
c
e
r
o
f

4

3

2

5
9

7
9

9
9

1
0

3
0

5
0

7
0

9
0

1
1

3
1

5
1

7
1

9
1

1
2

Source: European Commission 2018 autumn forecast, Ameco. 

5 

 
 
 
 
 
 
 
 
 
 
Box 1: Is secular stagnation a risk for the euro area?  

Japanification – a variant of secular stagnation  

The  persistence  of  low  real  GDP  growth  and  inflation  in  the  euro  area,  despite  very 
accommodative  monetary  policy  and  low  unemployment,  have  raised  concerns  that  this 
phenomenon  is  not  primarily  the  result  of  the  legacy  of  the  Great  Recession,  but  reflects  a 
long-term  trend.  The  main  explanations  for  this  trend  are  the  secular  stagnation  hypothesis5 
and a variant of it known as “Japanification”. 

The secular stagnation hypothesis argues that a structural (or secular) reduction in aggregate 
demand in advanced economies has led to a decline in the equilibrium (or natural) real interest 
rate,  potentially  even  below  the  effective  lower  bound  on  monetary  policy  interest  rates, 
resulting in chronically lower economic growth and inflation. Japan is often presented as the 
most  striking  example  of  a  country  experiencing  such  a  structural  shortfall  in  aggregate 
demand,  with  low  inflation  and  growth  since  the  early  1990s.  While  a  number  of  factors 
driving such a structural fall in aggregate demand have been posited6, the most prominent in 
Japan  are:  (i)  a  declining  working-age  population;  (ii)  rising  inequality  resulting  in  a  larger 
share of income  going to those with  a lower propensity to  spend;  (iii) increasing friction  in 
financial  intermediation,  initially  due  to  impaired  bank  balance  sheets  in  the  wake  of  the 
financial  crisis  and  subsequently  increased  regulatory  burdens;  (iv)  declining  productivity 
growth  and  by  extension  potential  growth.  The  broader  concern,  as  the  multi-decade  long 
duration  of  this  low-growth/low-inflation  phenomenon  in  Japan  suggests,  is  that  these 
dynamics can create a self-perpetuating trap, with lower consumption, and lower investment 
feeding each other and reducing long-term productivity and potential growth.   

Is it relevant for the euro area? 
While  not  all  the  aspects  of  secular  stagnation  are  relevant  for  the  euro  area,7  there  is  an 
increasingly widespread view that, following the Great Recession, the euro area shares some 
of the features of Japanification.8 The similarities between the euro area and Japan include not 
only  very  low  inflation  and  real  GDP  growth  despite  very  low  interest  rates  and  ample 
liquidity  but  also  low  productivity  and  potential  GDP  growth,  a  shrinking  working  age 
population,  a  troubled  banking  sector  that  constrains  credit  to  the  private  sector  and  a 
persistent current account surplus reflecting an excess of savings.9  

At  the  same  time,  there  are  important  differences:  first,  the  deleveraging  required  in  Japan 
following its financial crisis in the 1990’s was significantly greater than that in the euro area: 
total  credit to  the non-financial private sector in  Japan peaked at  218% of GDP in  the mid-
1990s  (and  since  fallen  to  161%  in  2018),  while  the  equivalent  peak  in  the  euro  area  was 
169% (in 2012). Secondly, the problems in the banking sector were treated relatively quickly 

5 Summers, L. (2014). “Reflections on the new 'Secular Stagnation hypothesis”, Vox article. 
6 Summers, L.  (2014) “Ibid.  
7 Roeger, W. (2014). “ECFIN’s medium term projections: the risk of ‘secular stagnation”. Quarterly Report on 

the Euro Area 13:4, pp. 23-29. 

8 See e.g. El-Erian, M. (2019). “How Western economies can avoid the Japan trap’. Project Syndicate, April 8; 
Donisau, P. (2019). ‘Is the Eurozone fated to Japanification?’ Global Perspectives (Wells Fargo), June 11; 
Brzeski, C. and I. Fechner (2019). ‘The eurozone’s Japanification – more to come’. Economic and Financial 
Analysis (ING), June 24. 

9 Kirkegaard, J. (2019) “Yes, We Are Probably All Japanese Now”, Monetary Dialogue, September 2019. 

6 

 
 
 
                                                 
in  the  euro  area,  with  the  peak  in  non-performing  loans  reached  three  years  after  the  crisis, 
while in Japan the level of non-performing loans peaked a decade after their crisis.10 Thirdly, 
the  demographic  drag  thus  far  in  the  euro  area  is  much  slower  than  that  in  Japan:  the  euro 
area’s working age population since 2009 has fallen by around 0.1% per year, while in Japan 
the average annual decline between 1993-2018 was 0.6% (and in the last decade reached 1% 
per  year).  Fourthly,  while  disinflationary  pressures  in  Japan  –  at  least  in the  first  decades  – 
were  driven  primarily  by  depressed  demand,  there  is  increasing  recognition  of  the 
disinflationary  impact  that  supply  side  factors,  namely  globalization,  technology  and  global 
value chains,  are now having on inflation in  the euro area and other advanced economies.11 
Finally, there are indications that the negative interest rates in the euro area may not simply be 
due  to  secular  stagnation,  but  also  financial  markets  fragmentation,  including  a  relative 
scarcity of safe assets.12 

Graph 4: Japan - persistently low growth and 
inflation 

Graph 5: ...despite significant fiscal 
expansion 

10

8

6

4

2

0

-2

-4

-6

-8

Primary balance (% of
GDP)- lhs
Gross debt (% of GDP)- rhs

Real GDP growth (%)
Inflation (%)

6

4

2

0

-2

-4

-6

-8

0
8

2
8

4
8

6
8

8
8

0
9

2
9

4
9

6
9

8
9

0
0

2
0

4
0

6
0

8
0

0
1

2
1

4
1

6
1

8
1

-10

0
8

3
8

6
8

9
8

2
9

5
9

8
9

1
0

4
0

7
0

0
1

3
1

6
1

Source: IMF World Economic Outlook database 

What are the policy implications? 

250

200

150

100

50

0

In the short-term, an appropriate policy mix in the euro area would combine accommodative 
monetary policy with a supportive fiscal stance focused on public investment and accelerated 
implementation of structural reforms.13 Structural reforms at both national and EU level can 
counter  disinflationary  pressures  through  a  number  of  channels:  reducing  structural 
unemployment  can  help  increase  the  activity  rate  and  help  decreasing  inequality,  while 
strengthening the conditions that support wage growth in surplus countries can help increase 
propensity to spend. Investment which remains low, can contribute both to increasing internal 
demand and potential growth in the long-run.  

10  Fujii,  M.  and  Kawai,  M.  (2010),  “Lessons  from  Japan’s  Banking  Crisis,  1991–2005.”  Asian  Development 

Bank Institute Working Paper 222/2010. 

11 Auer, R, C Borio and A Filardo (2017): “The globalisation of inflation: the growing importance of global 
value  chains”,  BIS  Working  Papers,  no  602,  January  and  Baldwin,  R  (2016):”  The  Great  Convergence: 

information technology and the new globalization,” Belknap Press. 

12 Borio C. and P. Disyatat (2011), “Global imbalances and the financial crisis: Link or no link?”, BIS Working 
Papers, No 346, Monetary and Economic Department, May; Giudice G. (2019), “Completing the Economic 
and Monetary Union with a European Safe Asset”, in European Financial Infrastructure in the Face of New 
Challenges, Allen F., Carletti E., Gulati M. and J. Zettelmeyer (eds.), European University Institute. 

13 See Draghi, M. (2019), Introductory Statement, ECB press conference, 12th September 2019.  

7 

 
 
 
 
 
 
                                                 
Over the medium to long-term however, it is possible the euro area will experience stronger 
demographic pressures that will require a stronger policy response. In particular, according to 
Eurostat’s  latest  baseline  long-term  population  projections,  the  decline  in  the  euro  area’s 
working-age population will accelerate sharply between 2020-4014, resulting in the working-
age cohort falling to 57.8% of the total population by 2040 (from 64.5% in 2018), below the 
share in Japan in 2018 (59.7%). If these projections materialise, they would call for policies 
that  will  offset  this  negative  shock  to  potential  growth,  by  increasing  the  working-age 
population and productivity. One policy could be a broad-based shift in public expenditure in 
the  euro  area  towards  productive  investment  that  can  boost  long-term  productivity  (i.e., 
environmental transition and digital infrastructure, as well as investment in up-skilling and re-
skilling  of  the  workforce).15  However,  a  growing  dependency  ratio  and  the  related 
expenditure in healthcare and pensions can reduce the share of public resources available for 
investment or current expenditure in younger generations. Fiscal and structural policies could 
also create incentives for greater workforce participation, in particular of women, and higher 
fertility rates.16 However, the experience of Japan shows fiscal policy alone, even if focused 
on  higher  expenditure  and  productive  investment,  is  insufficient  and  may  even  be  counter-
productive  (in  terms  of  raising  debt  ratios  without  raising  growth  significantly  –  see  charts 
above) if not accompanied by macro-structural reforms that directly tackle the root causes of a 
declining population  and low productivity.17 The structural reforms required will vary across 
the euro area countries according to their situation (i.e., demographic pressures are projected 
to  be  particularly  acute  in  Germany  and  Italy  but  in  France  the  working  age  population  is 
expected  to  rise).  Action  to  complete  EMU,  in  particular  to  improve  the  integration  of  its 
capital markets, could also contribute to reducing the risk of Japanification for the euro area 
by raising potential growth through greater financing for investment and innovation.18  

2. Convergence and inequalities 

Real convergence among euro area countries was deeply impacted by the economic and 
financial crisis but appears to be resuming again. On the back of the continued economic 
expansion,  convergence  in  living  standards  in  the  euro  area  has  resumed,  albeit  at  a  lower 
pace  compared  to  the  pre-crisis  period.  Real  convergence  in  GDP  per  capita  and  in 
unemployment has been stronger overall for Member States that have adopted the euro more 
recently  as  the  difference  between  euro  area-12  and  euro  area-19  countries  reveals  (Graph 
6)19.  Considerable  disparities  are  also  present  within  countries,  often  with  stark  divisions 
between capital city regions and the other regions.20 

14 The average annual decline in the working age population is projected to rise to 0.45% (from 0.1% over the 

last decade) according to Eurostat’s EUROPOP 2018 projections. 

15 Kirkegaard, J. (2019) “Yes, We Are Probably All Japanese Now”, Monetary Dialogue, September 2019. 
16 Blanchard, O. and Tashiro, T. “Fiscal Policy Options for Japan”, Policy Brief 19-7, May 2019. 
17  Japan: Staff Report for the IMF Article IV consultation, November 2018. 
18 Villeroy de Galhau, F., and J. Weidmann (2019), “Towards a genuine capital markets union”. 
19 Euro area 12 corresponds to all Member States that had adopted the euro by 2001. Euro area 19 are all euro 
area Member States today. The difference in euro area 12 and 19 corresponds mostly to Central and Eastern 
European Member States). 

20 Eurostat, (2019), Eurostat regional yearbook. 

8 

 
 
 
                                                 
Graph 6: Coefficient of variation of real GDP per capita and unemployment 

0,4

0,3

0,2

0,1

0,7

0,6

0,5

0,4

0,3

0,2

0,1

0

95 97 99 01 03 05 07 09 11 13 15 17 19 21

GDP per capita EA 12 (lhs)
GDP per capita EA 19 (lhs)
Unemployment EA 12 (rhs)
Unemployment EA 19 (rhs)

Note: EA 12 are euro area Member States that joined the euro before 2007. EA 19 are all current euro area Member States. 
Source:  AMECO, Eurostat.  Unemployment for EA 19 starts in 1998 due to data availability. 

While the euro area has seen several years of economic expansion, within countries, the 
effects  of  this  expansion  have  not  been  felt  evenly  throughout  society.  Net  disposable 
income growth has increased from 1% in 2010 in the midst of the crisis to 3.2% in 2018 and a 
large majority of Member States have seen declining poverty and social exclusion. This has 
been accompanied by  convergence towards the best  performers in  GDP-per-capita for some 
countries over the past few years following a period of increased divergences. The income of 
the  20%  highest  income  households  as  a  share  of  the  income  of  the  20%  lowest  income 
households21  which  had  increased  since  the  crisis  from  4.7  in  2006  to  5.2  in  2016, 
subsequently  marginally  declined  to  5.04  in  2017:  these  levels  vary  from  3.4  to  7.3  across 
euro area countries. At the same time, though increasing, the growth of disposable income has 
not  yet reached pre-crisis levels and in some Member States, the shares of people at  risk of 
poverty  and  social  exclusion  remains  above  2010  levels.  Inequality  at  high  levels  limited 
intergenerational  mobility,  increasing  precariousness  in  labour  market  relations,  and  the 
uneven  impact  of  globalisation,  climate  and  technological  change  on  people’s  lives  are 
creating a sense of vulnerability in certain parts of society. 

3. The macroeconomic policy stance  

Decisions on the macroeconomic policy stance need to be taken against the background 
of  persistent  low  inflation  and  a  weakening  and  uncertain  macroeconomic  outlook.  As 
signs  of  slower  growth  become  more  visible  also  the  risks  to  the  outlook  increase,  the 
macroeconomic  policy  will  need  to  respond  not  only  to  the  baseline  scenario  of  slightly 
slower growth but also to a scenario where risks materialise and where there is a significant 
slowdown  in  economic  activity.  This  would  notably  require  stepping  up  structural  policies 
and  standing  ready  to  use  fiscal  policy  to  support  monetary  policy  taking  into  account 

21 The income quintile ratio measures the ratio of the equivalised disposable income of the 20% highest income 

households to the income of the 20% lowest income, S80/S20. 

9 

 
 
 
 
 
                                                 
country-specific  circumstances.    Even  if  the  risks  do  not  materialise,  high  and  increasingly 
entrenched  uncertainty  is  sufficient  to  slow  growth  and  investment.  This  is  particularly 
relevant in a context where it is uncertain if the slowdown is of a cyclical nature or if it is a 
more long-term structural change. Persistently low euro area headline and core inflation and 
growth rates – that rebounded only shortly following a deep economic crisis  – are worrying 
signs for the long-term growth prospects. 

The  ECB  is  maintaining  an  accommodative  monetary  policy  (Graph  7).  In  September 
2019, the ECB lowered the deposit facility rate and introduced a two-tier system for reserve 
remuneration,  in  which  part  of  banks’  holdings  of  excess  liquidity  will  be  exempt  from  the 
negative  deposit  facility  rate.  It  also  modified  its  rate  forward  guidance  to  become  purely 
outlook-based. The ECB now expects to keep interest rates at the current or lower levels until 
inflation converges robustly to a level sufficiently close to, but below 2% over its projection 
horizon  and  this  convergence  has  also  been  consistently  reflected  in  the  dynamics  of 
underlying  inflation.  It  furthermore  announced  an  open-ended  restart  of  net  asset  purchases 
under  its  asset  purchase  programme  as  from  November  2019  and  the  intention  to  continue 
reinvesting  the  principal  payments  from  maturing  securities  purchased  under  the  asset 
purchase programme until after interest rates start rising. Finally, it announced lower rates and 
longer maturities for the new series of quarterly targeted longer-term refinancing operations.  

Graph 7: Monetary policy, euro area 

2

% 

Jan-07 = 100 

400

1,5

1

0,5

0

-0,5

ECB deposit facility rate
EONIA
Balance sheet total (rhs)

300

200

100

0

11

12

13

14

15

16

17

18

19

Source: ECB 

Better  fiscal  policy  coordination  among  euro  area  Member  States  would  result  in 
stronger  macroeconomic  outcomes.  Lack  of  buffers  and  only  moderate  fiscal  support  in 
Member States with more favourable positions, coupled with little reform effort at euro area 
and national  level,  would put  the burden to  counteract  the deflationary  effects  of a possible 
marked slowdown once again on the monetary policy. Pursuing prudent policies in high debt 
countries to put public debt credibly on a sustainable downward path, while further boosting 
high-quality investments in Member States with favourable fiscal positions could reduce the 
burden  on  monetary  policy,  help  overcome  the  low-inflation,  low-interest-rate  environment, 
and support nominal growth, thereby favouring deleveraging and rebalancing within the euro 

10 

 
 
 
 
area. Any policy package should combine short-term measures to sustain demand with long-
term ones to increase potential growth. The Eurogroup can play a useful role in coordinating 
ex ante this work. 

The  currently-expected  policy  mix  might  not  be  sufficiently  accommodative  should 
negative  risks  materialise.  The  outlook  appears  contingent  on  several  important  downside 
risks that share a high degree of uncertainty and interconnectedness. In the event of a broad 
based economic downturn, the full use of automatic stabilisers could provide for an effective 
response. This could be accompanied by selective discretionary counter-cyclical fiscal policy 
measures  in  case  extra  fiscal  support  is  needed,  especially  by  Member  States  that  have  a 
favourable fiscal position.   

A key question in a downside scenario is what would be the most effective fiscal response 
across Member States taking into account the respective fiscal space and severity of the 
downturn. The key principles  of discretionary  fiscal  expansion in  response to  an  economic 
shock are “timely, targeted, and temporary”.22 While public investment is considered to have 
the  highest  positive  fiscal  multipliers  and  is  thus  the  most  appropriate  response  to  an 
economic shock, in practice it is difficult to scale-up significantly given implementation lags 
(see box 2).  

Structural  reforms  are  needed  to  complement  macroeconomic  policies.  As  lower 
technology  adoption  results  in  slower  productivity  (see  section  5.2)  and  the  demographic 
change  further  takes  a  toll  on  growth  potential  looming  risks  of  secular  stagnation  ask  for 
appropriate  policy  responses  (see  section  1  and  box  1).  To  cater  for  the  possibility  that  the 
slowdown is not just a temporary one but rather a more extended period of low growth, fiscal 
and monetary policies need to be combined with an ambitious package of national structural 
policies  to  foster  economic  resilience,  growth  potential  and  a  sustainable  economy  (see 
section 5). Also, as there is little room for manoeuvre particularly in highly-indebted Member 
States, improving the quality and composition of public finances can contribute to build fiscal 
buffers while improving the growth outlook. Policies that favour education, employment and 
investment can increase growth potential in a budget neutral way. At the same time, the use of 
available  fiscal  space  to  support  investment  and  disposable  income  would  make  growth 
prospects less dependent on foreign demand.  

At  the  euro  area  level,  completing  the  EMU  would  reduce  uncertainty  and  support 
better macroeconomic outcomes. An incomplete EMU perpetuates financial fragmentation 
hindering  the  smooth  transmission  of  monetary  policy  across  the  euro  area.  This  limits 
financing  opportunities  for  much-needed  investment  and  undermines  the  potential  for  a 
stronger international role of the euro.  

22 Commission Communication, COM(2008) 800 final, 26/11/2008, 'A European Economic Recovery Plan'.  

11 

 
 
 
                                                 
Box 2: Effectiveness of fiscal policies in a downturn 

A  key  policy  question  relates  to  the  appropriate  design  of  an  effective  discretionary 
fiscal response in case of a broad-based downturn in the euro area.  In the case of large 
economic  shocks,  automatic  stabilisers  alone  may  not  be  sufficient  to  stabilise  output,  but 
need to be complemented with discretionary fiscal policy. While public investment is widely 
considered the first-best fiscal policy response to downturns given its high positive multiplier, 
in  practice  it  is  difficult  to  scale-up  significantly  given  implementation  lags.  As  a 
consequence,  policy-makers  often  resort 
to  other  stimulus  measures  with  varying 
macroeconomic stabilization impact.  

The  most  recent  instance  of  a  coordinated  discretionary  fiscal  stimulus  was  the 
European  Economic  Recovery  Plan  (EERP)23  of  December  2008  in  response  to  the 
Global  Financial  Crisis  (GFC).  The  plan's  main  objective  was  to  stimulate  aggregate 
demand over 2009-10 through a gross discretionary fiscal impulse of around 1.5% of GDP per 
year in the EU27 based on common principles of timely, temporary and targeted measures.24 
Given  the  implementation  lags  cited  above,  public  investment  spending  accounted  for  only 
around one-fifth of the total discretionary fiscal stimulus in the EU27 between 2009-10 (i.e., 
0.6%  of  GDP  cumulatively).25  A  larger  share  of  the  stimulus  was  aimed  at  households' 
purchasing power (1% of GDP cumulatively or one-third of the total), and businesses (0.8% 
of GDP cumulatively or 30% of the total), with the remainder aimed at labour markets (0.5% 
of GDP cumulatively or around a sixth of the total). Support to households came mainly via 
reductions in consumption, labour income taxes and employees’ social security contributions, 
as well as  higher  government transfers via expanded coverage of the unemployment  benefit 
and  social  assistance  system  (beyond  automatic  stabilisers).  Measures  targeting  labour 
markets included higher spending on short-time working (STW) schemes and job placement 
and  life-long  learning  services,  while  those  targeting  businesses  focused  mainly  on  cuts  in 
employers’ social security contributions. 

Table 1: European Economic Recovery Plan: Size and composition of discretionary fiscal stimulus 

Source: Report of Public Finances in EMU – 2010 

Measures were timely, temporary, well targeted and overall effective. The Commission's 
monitoring  of  the  Member  States'  recovery  plans  found  that  they  were  implemented  in  a 
timely manner, were mostly of a temporary nature (around three-fifths expired by 2011), and 
generally  well-targeted  in  that  they  focused  on  the  policy  areas  highlighted  by  the  EERP, 

23  Commission Communication, COM(2008) 800 final, 26/11/2008, 'A European Economic Recovery Plan'. 
24 The  net discretionary fiscal impulse  was equal to 1.1% of GDP in 2009 and 0.8% of GDP in 2010 because 

some Member States also implemented consolidation measures during this period.  

25   Report of Public Finances in EMU - 2010 

12 

Policy Area20092010Total% of totalType of measureHouseholds0,50,51,034%Transfers, consumption taxes, SSC employees, labour income taxesLabour market0,20,30,517%Government consumptionBusiness0,40,40,828%Reduction in employers' social security contributions (SSC)Investment0,30,30,621%Public invesmentTotal1,51,42,9100% 
 
 
 
 
 
 
                                                 
although  a  quantitative  assessment  of  their  impact  on  output  –  the  multipliers  –  was  not 
undertaken.26 An external quantitative assessment27 of the EERP using the ECB’s New Area-
Wide DSGE Model found the maximum fiscal multipliers for government spending on labour 
markets  (classified  as  consumption)  and  investment  were  above  one  but  those  for  all  other 
measures (labour income and consumption taxes, transfers, social contributions) were below 
0.3. As a result, the overall multiplier of the EERP was estimated at 0.57 by end 2009 and 0.6 
by end-2010, with an effect on output of 0.59% and 0.49% of GDP respectively.  

The  literature  on  the  impact  of  temporary  fiscal  stimulus  on  output  broadly  confirms 
the findings related to the EERP. The size of multipliers depends on the composition of the 
temporary stimulus as well as the degree of monetary policy accommodation.28 If there is no 
monetary  accommodation,  the  first-year  multipliers  from  a  temporary  two-year  EU-wide 
increase in government consumption for the first year range between 0.8 to 0.9 in the EU and 
then drop to zero as soon as the stimulus ends. The multiplier is slightly below unity due to 
modest crowding out of private domestic demand and reduction in net exports resulting from 
a rise in interest rates that depresses private domestic demand and drives real exchange rate 
appreciation. With monetary accommodation, the instantaneous multiplier from a temporary 
two-year  rise  in  government  consumption  is  above  unity  in  the  first  year  and  grows 
marginally  over  the  medium-term  because  output  remains  above  trend  following  the 
expiration of the stimulus, reflecting the persistent reduction of real interest rates. Moreover, 
while the literature focuses mostly on government consumption, there is significant variation 
in  the  size  of  multipliers  depending  on  the  type  of  temporary  fiscal  measures.  Table  2 
summarizes  the  average  first-year  multiplier  on  real  GDP  of  a  two-year  fiscal  stimulus 
accompanied  by  two  years  of  monetary  accommodation,  depending  on  the  type  of  stimulus 
measures undertaken. 

Table 2: First year multiplier by type of stimulus 

In  summary, 
it  would  be  prudent  for 
Member States to prepare contingency plans 
that could be activated in case a broad based 
on 
downturn  materialises, 
productive  yet 
In 
temporary 
addition  to  investment,  productive  spending 
could  include  government  consumption  and 
social  transfers  targeted  specifically  at  low-
income, cash-constrained households that could 
be  quickly  rolled  out.  These  measures  should  be  temporary  given  the  known  difficulties  to 
phase them out after the economic conditions improve. Tax cuts, as mentioned above, tend to 
have much lower multipliers than spending, but may be effective if targeted rather than broad-
based. If countries with relatively high debt would embark on spending reviews that identify 
savings to create room for productive spending, and seek to complement expansionary fiscal 

focusing 
spending. 

26   "Progress report on the implementation of the European Economic Recovery Plan" June and December 2009. 
27  Coenen,  Günter  &  Straub,  Roland  &  Trabandt,  Mathias,  (2013).  "Gauging  the  effects  of  fiscal  stimulus 
packages  in  the  euro area," Journal  of  Economic  Dynamics  and  Control,  Elsevier,  vol.  37(2),  pages  367-
386. 

28    This  paragraph  and  table  2  draw  on  the  review  of  seven  structural  dynamic  stochastic  general  equilibrium 
models used heavily by policymaking institutions and two academic DSGE models in Coenen et al. (2012),” 
Effects of Fiscal Stimulus in Structural Models.” American Economic Journal: Macroeconomics, 4 (1): 22-
68. 

13 

Type of fiscal stimulusMultiplierGovernment Consumption1.52Government Investment1.48Targeted transfers1.12Consumption taxes 0.66Labour income taxes0.53General transfers 0.29Corporate income taxes0.15 
 
 
  
                                                 
policies  with  well-designed  medium-term  fiscal  strategies  and  productivity-enhancing 
structural reforms they would be better prepared should a downturn materialize.29  

Moreover, beyond discretionary fiscal measures, there is scope in several Member States 
to increase the efficiency of automatic stabilisers.  The share of consumption  absorbed by 
the  tax  and  benefit  system  following  a  shock  to  market  income  ranges  from  64%  to  75% 
across  Member  States  and  is  around  70%  in  the  EU  as  a  whole.  30  Options  to  increase  the 
stabilization impact would be to adjust the features of selected revenue/expenditure categories 
in order to increase their response to economic activity, for example the replacement rate or 
duration  of  unemployment  benefits.  Alternatively,  automatic  changes  to  revenue  (tax)  and 
expenditure parameters  could be introduced  as a response to  macroeconomic developments, 
but concrete cases have been rare so far. Nevertheless, enhancing automatic stabilisers is not a 
panacea, since they can have a negative impact on the allocative efficiency such as prolonging 
unemployment spells, especially if these measures are not rescinded in good times. 

4. Budgetary policy 

4.1 Fiscal policy 

The  euro  area  fiscal  stance  is  expected  to  remain  broadly  neutral  to  slightly 
expansionary  in  2019  to  2021  but  national  fiscal  policies  are  not  expected  to  be 
appropriately  differentiated.  The  change  in  the  structural  balance,  points  to  a  broadly 
neutral fiscal stance in 2019, 2020 and 2021 by around 0.1 or 0.2 percentage points each year 
in a no-policy change scenario (Graph 8). Overall, the structural budget deficit is expected to 
widen from -0.8% of GDP in 2018 to -1.2% in 2021. A more expansionary fiscal stance, by 
around  ½  percentage  points  of  GDP  each  year,  is  forecast  when  looking  at  the  fiscal  effort 
based  on  the  structural  primary  balance  and  the  expenditure  benchmark31  which  are  not 
affected  by  ongoing  savings  in  interest  rate  expenditure.  While  Member  States  with  fiscal 
space are forecast to use part of it in 2020 to support economic growth prospects, broadly in 
line  with  the  recommendations  addressed  to  them,  a  number  of  highly-indebted  Member 
States are not expected to reduce their structural deficits. 

29 "World Economic Outlook," International Monetary Fund (2016). 
30 Mohl, Mourre and Stovicek (2019), "Automatic Fiscal Stabilisers in the EU: Size & Effectiveness" European 

Commission, Economic Brief 045. 

31  Compared  with  the  change  in  the  structural  primary  balance,  this  indicator  uses  a  (lower)  medium-term 

potential growth as a reference and does not benefit from some revenue windfalls projected in 2019. 

14 

 
 
 
 
                                                 
Table 1: General Government budgetary position 

Source: European Commission 2019 Autumn forecast, Ameco. 
Note: contributions to change in actual balance may not add up to total due to rounding. 

The  euro  area  debt-to-GDP  ratio  is  gradually  decreasing.  The  aggregate  debt-to-GDP 
ratio has been on a declining path since 2014 (Table 1 and Graph 10), when it reached a peak 
of 95%. In 2018, the debt ratio fell to 87.9% and it is projected to fall further over the forecast 
period  to  reach  around  84%  in  2021,  under  a  no-policy-change  assumption,  thanks  to 
favourable interest-growth differentials and primary surpluses. However, public debts are not 
projected  to  decline  in  some  highly-indebted  Member  States  and  a  sharp  downturn  could 
compromise further debt reduction in the euro area aggregate (Graph 11).  

Headline  deficit  improvements  seen  since  2011  seem  to  have  halted.  The  euro  area 
aggregate deficit has declined by 5.7 percentage points of GDP since 2010, to 0.5% of GDP in 
2018,  the  lowest  level  since  2000  (Table  1,  Graph  9).  To  this  reduction  contributed  the 
sizeable  consolidation  packages  adopted  in  2011-2013  and  the  working  of  automatic 
stabilisers  afterwards,  with  actual  economic  growth  outpacing  potential  growth.  Between 
2014  and  2018,  the  reduction  in  the  headline  budget  deficit  was  supported  by  the  cyclical 
upswing and the low interest rate environment. The expenditure ratio decreased by some 2pp 
since  2014  to  around  47%  of  GDP  (Table  1)  while  revenues  declined  by  less  than  half  a 
percentage point of GDP over the same period. Lower growth expected in 2019 seems to be 
reversing the trend. With the euro area economy moderating in the coming quarters and with 
risks to the downside this improvement in the fiscal position may be put at risk. The aggregate 
deficit  is  forecast  to  increase  in  2019,  2020  and  2021  to  0.8%,  0.9%,  and  1%  respectively 
given  the  less  favourable  cyclical  conditions  and  discretionary  expansionary  measures 
planned  in  the  2020  Draft  Budgetary  Plans  which  more  than  offset  the  expected  decline  in 
interest expenditure.  

Member  States  have  been  slow  in  improving  the  quality  of  public  finances.  Euro  area 
Member States took only limited measures to implement 2018 CSRs related to public finances 
and taxation. While fiscal frameworks in Member States generally conform to the minimum 
EU  requirements  in  this  area,  ensuring  that  national  fiscal  rules  and  institutions  operate 

15 

20142015201620172018201920202021Total receipts (1)46.846.446.246.246.546.346.245.9Total expenditure (2)49.348.447.747.247.047.147.147.0Actual balance (3) = (1)-(2)-2.5-2.0-1.4-0.9-0.5-0.8-0.9-1.0Interest expenditure (4)2.62.32.11.91.81.71.51.4Primary balance (5) = (3)+(4)0.10.30.71.01.30.90.60.4One-offs (6)-0.2-0.20.1-0.1-0.1-0.20.00.0Cyclically-adjusted budget balance (7)-1.0-1.0-0.9-1.1-0.9-1.1-1.1-1.2Cyclically-adjusted primary balance (8) = (7)+(4)1.61.41.20.90.90.60.40.2Structural budget balance (9) = (7)-(6)-0.8-0.8-1.0-1.0-0.8-0.9-1.1-1.2Structural primary balance (10) = (7) -(6)+(4)1.81.51.21.01.00.70.40.2Change in actual balance:of which change in:                 - Cycle0.40.50.70.3-0.1-0.1-0.1                - Interest (inverse)0.30.20.20.10.20.10.1                - One-Offs0.10.2-0.1-0.10.00.20.0                - Structural primary balance-0.3-0.3-0.20.1-0.3-0.4-0.2Change in structural budget balance0.0-0.10.00.2-0.1-0.2-0.1Public debt (% GDP)95.193.092.289.887.986.485.184.1 
 
 
smoothly  and  guide  fiscal  policy  over  the  short-  and  medium-term  requires  continuous 
monitoring  and  effort.  In  return,  effective  and  efficient  fiscal  frameworks  can  improve  the 
quality of fiscal policy, both in terms of its macroeconomic stance and composition of budgets 
and  in  this  way  mitigate  the  tension  between  stabilisation  and  sustainability  goals.  The 
improvement of the quality of public finances should go hand in hand with the development 
of green budgeting practices and benchmarks. 

Graph 8: Change in the structural balance (SB) and structural primary balance (SPB), euro area 

1,75

1,50

1,25

1,00

0,75

0,50

0,25

0,00

-0,25

-0,50

% of potential GDP 

-3,5

Change in SB

Change in SPB

Output Gap (rhs inverted)

forecast 

-3,0

-2,5

-2,0

-1,5

-1,0

-0,5

0,0

0,5

1,0

n
e
u
t
r
a
l

B
r
o
a
d
l
y

11

12

13

14

15

16

17

18

19

20

21

y
r
a
n
o

i
t
c
a
r
t
n
o
C

y
r
a
n
o

i
s
n
a
p
x
E

Graph 9: Government budget balance, euro area 

0,0

-1,0

-2,0

-3,0

-4,0

-5,0

-6,0

-7,0

forecast 

Structural budget balance
Headline budget balance

% GDP 

10 11 12 13 14 15 16 17 18 19 20 21

Graph 10: Government debt, euro area 

100

% GDP 

forecast 

14

15

16

17

18

19

20

21

95

90

85

80

75

16 

 
 
 
 
 
 
 
 
 
Graph 11: Government gross debt, 2019 

Graph 12: Government headline balance, 2019 

% GDP 

2019
EA-Avg 2007
EA-Avg 2019

160

140

120

100

80

60

40

20

0

% GDP 

5

4

3

2

1

0

-1

-2

-3

-4

E
E

U
L

V
L

T
L

T
M

K
S

L
N

E
I

E
D

I
F

I
S

T
A

A
E

Y
C

S
E

R
F

E
B

T
P

T
I

R
F

S
E

T
I

E
B

I
F

K
S

V
L

E
E

T
P

T
L

E
I

T
A

I
S

E
D

T
M

L
E

L
N

U
L

Y
C

Sources: European Commission 2019 [spring] forecast (Graphs 4, 5, 6), ECB (Graph 3). 

4.2. Expenditure policy  

While spending reviews are critical in improving the quality of public finances, they are 
seldom  incorporated  into  budget  decisions.  By  keeping  expenditure  in  check  and 
addressing  its  efficiency,  spending  reviews  help  creating  room  to  build  fiscal  buffers  (see 
section 4), improve fiscal sustainability and are also a fitting tool to boost high-quality public 
spending.  Focused  reviews  on  spending  reprioritisation  could  make  room  to  increase 
productive  spending  in  priority  areas  and  help  preserve  the  public  investment  envelope  in 
cyclical downswings, when investment is most vulnerable32. Engaging in spending reviews in 
large areas of expenditure such as pensions or health can improve the long-term sustainability 
of public finances. But while political commitment with spending reviews in the euro area is 
increasing, only a minority of Member States incorporates decisions from  spending reviews 
into their budget planning.33 Public procurement – the buying of works, goods or services by 
public  bodies  –  is  one  of  the  largest  expenditure  items  accounting  for  over  14  %  of  EU 
GDP34. However, according to the Single Market Scoreboard, there are still large differences 
within the euro area in terms of public authorities’ performance in getting the best value for 
money in their purchases. In 2018, some Member States still had unsatisfactory performance 
in terms of applying public procurement best practices.  

Public  investment  –  which  is  key  for  increasing  productivity  and  potential  growth  – 
remains at historically low levels. Public investment declined by almost 1% GDP since the 
beginning  of  the  crisis  and  barely  increased  since  2014  while  social  benefits  and 
compensation  of  employees  remained  broadly  stable  as  a  share  of  GDP  (Graph  13).  It  is 
projected to increase only marginally over the forecast horizon (close to 2.9% in 2021, from 
2.7% in 2018) and thus remain below its pre-crisis average (3.2% of GDP over 2000-2005). 

32  European  Commission,  “Spending  reviews  as  a  key  tool  to  enhance  public  investment  in  the  Euro  Area.”, 

Technical note for the Eurogroup, September 2019. 

33 “Spending reviews for smarter expenditure allocation in the Euro Area.”, Note for the EPC, 19 June 2019. 
34  Making Public Procurement work in and for Europe COM(2017) 572. 

17 

 
 
 
 
 
                                                 
Increasing public investment levels and investment quality could play a role in fostering long-
term growth (see section 1) given the positive effect of public investment on potential growth 
and  labour  productivity35.  Increasing  public  investment  can  be  achieved  in  a  budgetary-
neutral  way  in  those  countries  that  lack  fiscal  space  by  improving  the  efficiency  of  current 
spending.  High-quality  investments,  particularly  in  research  and  development,  network 
industries  (provided  there  is  no  overprovision)  and  education  could  boost  these  countries 
competitiveness.  In  surplus  countries  additional  investment  spending  would  boost  potential 
growth  while  also  contributing  to  rebalancing  in  the  euro  area.  There  is  increasing 
coordination within the EU to identify the priority areas for investment (see section 4.2). 

Graph 13: Government expenditure, euro area 

Graph 14: Composition of tax revenues* 

4,0

% GDP 

% GDP 

18

3,5

3,0

2,5

2,0

t
s
a
c
e
r
o
f

Government investment expenditure
Compensation of employees (rhs)
Social benefits (rhs)

5
0

6
0

7
0

8
0

9
0

0
1

1
1

2
1

3
1

4
1

5
1

6
1

7
1

8
1

9
1

0
2

1
2

16

14

12

10

8

45

40

35

30

25

20

15

10

5

0

% GDP 

Labour
Consumption
Recurrent property
Environmental

I
F

R
F

T
A

T
I

E
B

I
S

L
N

E
D

E
E

L
E

T
P

V
L

K
S

Y
C

U
L

S
E

T
L

T
M

E
I

* Consumption taxes often include environmental taxes, thereby total tax revenues presented in Graph 10 may be inflated. Data for 2017. “Other taxes”: all taxes 
that are not labour, value added, corporate income, environmental, or recurrent property taxes (e.g capital taxes such as on capital gains or inheritances and some 
consumption taxes such as on imports or alcohol and tobacco). Labour taxes includes employers’ and employees’ social contributions.  
Source: European Commission 2019 autumn forecast, Ameco (Graphs 7, 8, 9), European Commission, Taxation trends in the European Union, 2019 (Graph 10). 

Improving  Member  States’  public  investment  strategies  is  essential  to  face  long-term 
challenges.  Investment  now,  would  benefit  future  generations  if  used  to  tackle  long-term 
changes in  technology,  climate and skills  needs.  Investment  in  infrastructure, education  and 
innovative  activities  adds  to  a  country’s  capital  stock,  which  enhances  the  economy’s  long-
run  productivity  growth.36  Coordinated  investments  among  Member  States,  and  between 
private  and  public  sector,  will  be  essential  to  achieve  the  Paris  Agreement  objectives  of 
emission  reduction,  energy  efficiency,  and  renewables  targets.  An  additional  EUR  260 
billion37  in  annual  investment  compared  with  the  baseline  for  the  EU  as  a  whole  would  be 
needed  to  reach  the  2030  climate  and  energy  targets.  Interventions  to  replace  dirty 
technologies  with  their  clean  counterparts  are  expected  to  play  a  significant  role  in  the 
reallocation of capital and labour between sectors within countries38. The same can be said for 
the need to upgrade skills to face the upcoming challenges. New ways of working and rapid 

35 Fournier, J. (2016), The positive effect of public investment on potential growth, OECD. 
36 Johansson, A. (2016), “Public Finance, Economic Growth and Inequality: A Survey of the Evidence”, OECD 

Economic Department Working Papers, No. 1346, OECD Publishing. 

37 “United in delivering the Energy Union and Climate  Action  - Setting the  foundations for a successful clean 

energy transition” COM(2019) 285, European Commission.  

38 Ardagna (2019), “Growing Green”, European Economic Analyst, Economics Research, Goldman Sachs. 

18 

 
 
 
 
 
 
 
                                                 
 
technological  change  are  affecting  the  types  of  skills  needed.  High  skills  enable  people  to 
adapt to unforeseen changes. Similarly, the transition to a low carbon and circular economy 
means  creating  and  adapting  to  business  models  and  job  profiles.39  If  public  investment  is 
coupled with structural reforms, more regulatory certainty is  given to businesses. The BICC 
can be key in this strategy since it will combine investment and structural reforms at member 
state level coordinated at euro area level. 

Green  budgeting  practices,  which  can  enable  fiscal  policy  to  address  directly  climate 
challenges,  remain  underdeveloped  in  most  Member  States.  Presenting  transparently  the 
extent to which national budgets contribute to the achievement of environmental objectives, 
conducting environmental impact assessments, assessing greenness of taxes, freeing up fiscal 
space for green investments and incentive schemes for private investments in a budget-neutral 
approach are measures that can be taken in the framework of green budgeting. The framework 
for  assessing  debt  sustainability  would  also  need  to  consider  impacts  of  extreme  weather 
events  and  gradual  temperature  rises  on  fiscal  outcomes  and  growth,  public  finance  and 
economic  costs  of  Member  States  emission  reduction  commitments  as  well  as  impacts  and 
costs  of  macro-relevant  adaptation  measures.  Only  a  few  Member  States  explicitly  identify 
environmental  measures  within  budgetary  documents  in  a  way  that  can  track  effort  and 
progress towards environmental goals. In those cases where such practice exists, a consistent 
and coherent approach for the presentation of environmentally-friendly measures is missing. 
A  coherent  link  between  Climate  Action  plans  and  expenditure  policies  would  improve  the 
quality and impact of public spending on climate challenges. 

4.3 Tax Policies  

Rethinking  the  overall tax  mix,  including  labour  taxation  would support  inclusive  and 
sustainable growth. A level-playing field on taxation and shifting taxes towards more growth 
friendly tax basis would contribute to a more resilient euro area. In times of transition towards 
a greener and digital economy, tax systems need to be designed to deliver on the objectives of 
green  investment  and  environmental  sustainability,  better  employment  opportunities,  a  fair 
burden-sharing,  and  fiscal  responsibility.  The  overall  tax  burden  in  the  euro  area  is  skewed 
towards  labour  (including  social  contributions)  with  property  or  environmental  taxes 
representing a very small share of tax revenues (Graph 14). To finance its  reduction, the tax 
burden  could  be  shifted  towards  tax  bases  that  are  less  detrimental  to  growth.  At  the  same 
time, a high tax burden on labour, particularly for low-income and second earners, can be an 
impediment  for  job  creation  and  labour  market  participation.  Targeted  tax  cuts  for  those 
groups  can  thus  be  an  important  instrument  as  part  of  a  broader  policy  package  for  a  just 
transition to a greener economy.40  

39 Commission Communication, COM(2016) 381 final, ‘A new skills agenda for Europe’. 
40 Brys, B., et al. (2016), "Tax Design for Inclusive Economic Growth", OECD Taxation Working Papers, No. 

26, OECD Publishing, Paris, https://doi.org/10.1787/5jlv74ggk0g7-en. 

19 

 
 
 
                                                 
Environmental taxation can contribute to sustainable growth by incentivising “greener” 
behaviour by producers, users and consumers. Energy, transport, as well as resource and 
pollution  taxes  differ  significantly  across  countries,  in  particular  in  how  carbon  and  energy 
content  are  taken  into  account  when  taxing  energy  products41.  At  EU  level  a  review  of  the 
Energy Taxation Directive could be helpful in this regard since it has not kept pace with the 
developments  in  the field of energy  efficiency  and climate change. A first  evaluation  of the 
current  Directive  was  already  undertaken  by  the  Commission  services.  It  provided  a  first 
technical  assessment on  the need for restructuring the framework for the taxation of energy 
products  and  electricity  given  the  significant  changes  which  took  place  in  technologies, 
national  taxes  and  energy  markets  since  200342.  However,  as  environmental  taxes  often  hit 
low-income  earners  particularly  hard,  it  is  important  to  accompany  their  increased  use  with 
measures mitigating the impact on the vulnerable groups. Also, a Carbon Border Tax would 
contribute to avoid carbon leakage and by this to reduce total CO2 emissions in the world.  

There  has  been  a  race  to  the  bottom  in  recent  decades  in  corporate  taxation  and  the 
international  corporate  tax  system  is  out  of  step  with  the  realities  of  the  modern 
economy.  Corporate  income  tax  rates  have  fallen  significantly  over  the  past  three  decades 
worldwide.43  The  euro  area  is  no  exception,  at  least  in  the  last  decade  where  the  average 
statutory tax rate has fallen from 32% in the year 2000 to 24% in 201944. While this reduction 
in  rates  has  not  so  far  resulted  in  a  corresponding  decrease  in  revenue,  scope  for  further 
broadening the corporate tax base may be limited. The ease with which mobile resources can 
move  within  the  euro  area  increases  the  scope  for  tax  competition  between  euro  area 
economies.  Excessive  tax  competition  risks  distorting  businesses’  investment  decisions  and 
leading  to  tax  policies  aimed  at  short-term  tax  collection  rather  than  at  long-term  economic 
growth, jobs and social fairness. Together with the occurrence of tax avoidance, it also risks 
undermining  faith  in  the  fairness  of  the  overall  tax  system.  Corporate  taxation  systems 
currently do not ensure that profits are taxed where they are generated, particularly given the 
increasing weight of the digital economy. Coordination among Member States is essential to 
address profit-shifting and tax competition and to ensure a lasting, efficient and fair approach 
for international taxation. An EU agreement for a Common Consolidated Corporate Tax Base 
would  contribute  to  this  and  in  the  long-run  increase  growth  in  the  EU  by  up  to  1.2%45. 
Positive impacts would also come from reviewing profit allocation among countries at global 
level  and  ensuring  minimum  effective  taxation.  The  need  to  finance  investments  in  climate 
change adaptation and decarbonisation of the euro area economies should bring new impetus 
to the EU proposals in this area. From this perspective, improving tax collection would reduce 
the recourse to debt. 

41 Economic Policy Committee note 2019: “The quality of public administration”. 
42  Commission  Staff  Working  Document,  SWD  (2019)  329  final,  evaluation  of  the  Council  Directive 
2003/96/EC  if  October  2003  restructuring  the  Community  framework  for  the  taxation  of  energy  products 
and electricity. 

43  IMF  (2018),  “Tax  Policy  Measures  in  Advanced  and  Emerging  Economies:  A  Novel  Database”,  Working 

Paper No. 18/110. 

44 European Commission (2019), “Taxation Trends in the European Union”. 
45 COM(2019) 8, “Towards a more efficient and democratic decision making in EU tax policy”. 

20 

 
 
                                                 
Addressing tax fraud, evasion and aggressive tax planning (ATP46) are essential to make 
tax systems  more efficient and fairer.  These are essential to  secure  government  revenues, 
impede  distortions  of  competition  between  firms,  provide  tax  certainty  for  businesses, 
preserve social cohesion and fight increasing inequalities. Recent studies47 find that corporate 
tax avoidance in the EU-28 entails more than EUR 35 billion of corporate tax revenues losses 
annually.48  In  particular,  a  study  commissioned  by  the  European  Parliament  finds  that  the 
revenue loss from profit shifting within the EU amounts to about EUR 50-70 billion. These 
revenue losses are very sizeable, including when compared to the investment needs to address 
climate change. The mobility of capital, which has increased with the introduction of the euro 
and  the  ensuing  suppression  of  currency  risks,  facilitates  tax  arbitrage  by  multinational 
enterprises operating within  the euro area, which make the adoption of  measures to  address 
ATP particularly urgent for euro area Member States. ATP has clear spillover effects within 
the  euro  area  as  it  creates  a  tax-induced  redistribution  of  tax  revenues  across  euro  area 
Member States on top of an overall loss due to lower effective taxation. 

Tax simplification and addressing the debt bias in corporate taxation would contribute 
to improving tax systems. This could improve the resilience of tax systems, provide certainty 
for  businesses  and  contribute  to  investment  and  innovation,  as  well  as  improving  tax 
compliance.  Most  euro  area  Member  States’  corporate  tax  systems  still  favour  debt  over 
equity  financing.  Reducing  or  eliminating  this  debt  bias  would  contribute  to  reducing 
financial  stability  risks.  Continued  efforts  should  be  made  to  simplify  tax  systems  by 
decreasing  loopholes,  duplications  and  improving  the  rules  transparency  while  considering 
well-designed  tax  incentives  to  boost  real  investment,  including  in  the  green  economy. 
Improving the  capacity  of the tax administration could  contribute to  decrease tax avoidance 
and ensure tax collection from the entire tax base thereby creating space to reduce/reorient the 
tax burden. 

5. Structural issues 

in 

the  context  of 

Reform progress by euro area countries remains moderate despite efforts to strengthen 
implementation 
the  European  Semester.  Country  Specific 
Recommendations  (CSR)  provide  economic  policy  guidance  to  Member  States  on  what 
should  be  their  reform  priorities.  From  an  annual  perspective,  Member  States’  progress  in 
CSR  implementation  has  been  decreasing  steadily  since  2013  (European  Commission 
calculations).49 This shows some reform fatigue after a stronger reform effort in the post-crisis 

46  ATP  consists  in  taxpayers'  reducing  their  tax  liabilities  through  arrangements  that  may  be  legal  but  are  in 
contradiction  with  the  intent  of  the  law.  It  occurs  through  three  main  channels:  debt  shifting,  strategic 
location of intellectual property rights and intangibles assets and misuse of transfer pricing. 

47 Álvarez-Martínez, M., Barrios, S., d'Andria, D., Gesualdo, M., Nicodème, G., & Pycroft, J. (2018). How 
Large is the Corporate Tax Base Erosion and Profit Shifting? A General Equilibrium Approach. CEPR 
Discussion Papers 12637. 

48 Tørsløv, T., Wier, L., & Zucman, G. (2018). The Missing Profits of Nations. NBER Working Paper 24701. 
49  In  2013,  the  progress  in  CSR  implementation  by  euro  area  countries  accounted  for  39%,  while  in  2018  the 
progress was of 33%. Each CSR is assessed qualitatively every year on implementation progress from “no 

21 

 
 
 
                                                 
 
period.  In  terms  of  average  annual  assessment  of  progress  in  implementing  CSRs  by  broad 
policy  areas  between  2013  and  2018,  progress  in  the  financial  sector  was  the  highest  (see 
section 6), followed by the progress in public administration & business environment (section 
5.2), labour market, education & social policies (section 5.1) and public finances (section 4). 
However, the area of structural policies, which together with public administration are crucial 
for  institutional  quality  (see  below  and  section  5),  saw  the  lowest  implementation  ratio.  In 
terms of individual policy areas, the average annual progress in CSR implementation between 
2013  and  2018  was  below  50%50  on  all  of  them  apart  from  financial  services,  access  to 
finance and insolvency frameworks (Graph 15). Areas where reform effort stayed below 30% 
were the debt bias, broadening the tax base, and competition in services and telecoms.   

increase 

The  Commission  has  made  concrete  efforts  to  make  the  European  Semester  more 
the  ownership  by  Member  States.51  The  number  of 
effective  and 
recommendations has been reduced and their content made more focused, while leaving room 
for  Member  States  to  act  in  line  with  their  national  practices  and  situations.  Social 
considerations  have  been  prioritised  and  mainstreamed  in  line  with  the  European  Pillar  of 
Social  Rights  and  through  the  use  of  the  Social  Scoreboard.  The  Commission  took  several 
initiatives  to  promote  dialogue,  reach  out  to  stakeholders,  increase  national  ownership  of 
reforms and consult Member States on the analytical parts of their country reports prior to the 
publication.  The  Commission‘s  Structural  Reform  Support  Service  also  provides  targeted 
reform  assistance  to  Member  States,  at  their  request,  to  support  them  in  design  and 
implementation of reforms. 

progress” to “full implementation”. In order to be able to make aggregate analysis across countries and over 
time,  a  quantification  is  given  to  each  assessment  level:  no  progress  =  0;  limited  progress  =  25;  some 
progress = 50; substantial progress = 75; full implementation = 100. 

50 Idem. 
51 European Commission press-release IP-19-2813 

22 

 
 
                                                                                                                                                         
Graph 15: Average of annual assessment of implementation of CSRs for euro area countries (2013-
2018) 

0

10

20

30

40

50

60

Structural policies Total
Transport
Telecom, postal services & local public services
Research & innovation
Energy, resources & climate change
Competition in services
Competition & regulatory framework

Public finances & taxation Total
Reduce the tax burden on labour
Reduce the debt bias
Long-term sustainability of public finances, inc. pensions
Fiscal policy & fiscal governance

Fight against tax evasion, improve tax administration &…

Broaden tax bases

Public administration & business environment Total
State-owned enterprises
Shadow economy & corruption
Public administration
Insolvency framework
Civil justice
Business environment

Labour market, education & social policies Total
Wages & wage setting
Unemployment benefits
Skills & life-long learning
Poverty reduction & social inclusion

Incentives to work, job creation, labour market…

Health & long-term care

Employment protection legislation & framework for…

Education
Childcare
Active labour market policies

Financial sector Total
Private indebtedness
Housing market
Financial services
Access to finance

Source: European Commission CSR database. 
Note: This graph shows the average of the annual implementation scores of country-specific recommendations per policy area. The scores attributed are 25 for 
'limited progress', 50 for 'some progress', 75 for 'substantial progress', and 100 for 'fully implemented'. Data has been collected since 2011, but 2013 saw a major 
break in series. Comparison is thus more reliable as of 2013.  

Box 3: Progress in addressing the 2019 EARs  

implementation  of  the  euro  area 
This  box  makes  a  first  assessment  of  the 
recommendations  (EARs).  A  more  complete  review  of  progress  in  implementing  the  euro 
area  recommendation will be published in  next  year’s SWD, based on a  methodology to  be 
elaborated  and  discussed  with  euro  area  Member  States  and  institutions  in  the  relevant 
committees. 

Going forward, the goal will be to provide an overview of progress for the euro area as a 
whole  in  implementing  previous  year’s  EARs.  First,  the  assessment  takes  into  account 
reforms that were undertaken at national level or at European level where relevant. Second, it 
takes into account policy outcomes, including at the euro area level and available assessments 
at  country  level.  In  the  cases  where  a  recommendation  is  addressed  to  a  specific  group  of 

23 

 
 
 
 
Member States (such as member states with high debt levels or external surpluses) only those 
are  considered  for  assessing  progress.  Overall,  following  the  euro  area  recommendation 
published last year, the following qualitative assessment can be made.  

Some  reform  progress  was  achieved  to  increase  potential  growth,  competitiveness  and 
productivity (EAR 1, see sections 1, 2, 5 and 5.2). The rate of Single Market integration has 
slowed down and the level of integration remains low in services with significant remaining 
gaps. National reforms in the areas of research and innovation, competition and services have 
been progressing but reforms in the areas of network industries and sustainability progressed 
only  slowly.  Most  Member  States  improved  their  business  environment  scores  but  large 
differences  remain  and  there  was  no  significant  improvement  in  many  aspects  pertaining  to 
the  quality  of  national  public  administrations.  Most  Member  States  with  persistent  current 
account  deficits  have  reduced  their  deficits  or  turned  them  into  surpluses  but  productivity 
decreased  or  remained  broadly  unchanged  in  particular  in  some  Member  States  with  large 
deficits. There was some progress in promoting wage growth, among the Member States with 
current  account  surpluses  though  wage  gains  were  overall  modest  and  in  some  cases  below 
inflation. Investment in these same countries has been sustained and increased in some cases 
though investment levels are projected to weaken for some countries over 2019-20. 

On the fiscal recommendation (EAR 2), progress has stalled. There continues to be lack of 
differentiation in Member States’ fiscal policies (see section 3). The expected fiscal effort for 
2019-20 by Member States with  high debt  levels  is  negative or neutral,  in  contrast  with  the 
recommendation to rebuild fiscal buffers while Member States with fiscal space are forecast 
to use only part of it to support economic growth prospects. Public investment and the share 
of  growth-enhancing  expenditure  remain  low  with  only  a  few  Member  States  incorporating 
spending reviews decisions into their budget planning. Private investment is forecast to reach 
pre-crisis  levels  in  2019-2020. Progress  is  also  limited in  tackling Aggressive Tax Planning 
(ATP) where there remains scope for further action through the coordination of national tax 
policies.  Furthermore,  discussion  at  the  Council  have  stalled  on  proposals  such  as  the 
CCCTB, which would contribute to fighting ATP (see section 4.3). 

Following years  of economic expansion and job creation, the labour market and social 
situation continues to improve, but challenges remain. The unemployment rate continued 
to  decrease,  with  significant  differences  persisting  across  Member  States.  Member  States 
adopted  reforms  to  increase  the  number  of  people  active  on  the  labour  market  but  labour 
market  segmentation  remains  a  source  of  concern,  as  well  as  in-work  poverty.  In  some 
countries,  efforts  are  ongoing  to  promote  open-end  hiring  and  to  reinforce  labour 
inspectorates. Moreover, in a context of rising skills shortages and mismatches, policy action 
was  taken  to  better  link  the  education  and  training  system  to  labour  market  needs.  Some 
countries are making efforts to adapt social protection systems to a changing world of work, 
including by ensuring adequate coverage to non-standard workers and self-employed. A few 
Member  States  are  taking  action  to  reinforce  their  income  support  schemes,  while  targeting 
carefully support to those most in need and by promoting activation of beneficiaries. Finally, 
several Member States supported employment and labour income by reducing the tax wedge. 

The  euro  area  and  its  Member  States  took  several  actions  to  improve  the  resilience  of 
the financial sector (EAR 4, see section 6). The revision of the ESM Treaty providing the 
common  backstop  to  the  Single  Resolution  Fund  is  under  discussion  and  a  High  Level 
Working  Group  (HLWG)  was  established  concerning  the  European  Deposit  Insurance 
Scheme  (EDIS).  Though  the  Commission  delivered  on  all  of  the  actions  announced  in  the 
Capital Markets Union (CMU) and the co-legislators reached at least political  agreement on 

24 

 
 
  
13 of the 16 Commission proposals, further steps are needed to build a genuine CMU.  Non-
performing  loan  levels  have  been  substantially  reduced  with  only  a  few  exceptions,  while 
private debt levels have decreased for households, though not for non-financial corporations. 

On deepening the EMU, progress has been slow (EAR 5, see section 7). There has been 
some progress on the economic union,  with  a political  agreement on  a euro area Budgetary 
Instrument  for  Convergence  and  Competitiveness  and  on  improving  the  ESM’s  toolkit. 
However, there was no progress towards a euro area-wide fiscal stabilisation function or on 
euro  area  governance  proposals.  Lack  of  progress  in  completing  the  EMU  hinders  the 
development of the global role of the euro. 

5.1 Institutional aspects and public administration 

Strengthening  institutional  quality  at  national  level  would  be  key  in  improving  the 
delivery of structural reforms. Well-performing public institutions are a precondition for the 
successful delivery of structural reforms52 as successful reform depends on good governance, 
effective  law  making  and  implementation,  independent  and  efficient  justice  systems  and 
overall quality of public administration.53 Public Administration and Business environment is 
another  area  crucial  for  institution  quality,  and  there  progress  in  CSR  implementation  was 
similar  to  other  broad  policy  areas.  Focusing  on  improving  the  effectiveness  of  the  public 
administration, including justice systems, as well as the quality and stability of the regulatory 
environment  could  contribute  to  improve  the  reform  pace  and  the  appropriateness  of  the 
reforms undertaken to current and future challenges.   

A  well-functioning  public  administration  requires  action  in  several  areas,  from 
accountability,  to  management  of  financial  and  human  resources  as  well  as  quality  of 
service delivery. An efficient tax administration and low tax compliance costs, a regular and 
transparent  budget  cycle  of  planning,  negotiation  and  implementation  and  efficient  public 
procurement are essential for the quality of public financial management. An indicator-based 
assessment  framework  on  public  administration54  has  been  developed  by  the  European 
Commission  to  identify  public  administration  reform  priorities  in  Member  States.55  The 
framework  considers  that  effective  policymaking  requires,  among  other  things,  strategic 
planning,  coordination,  parliamentary  oversight  of  government  policy  making,  public 
consultation, and ex-ante and ex-post evaluation of regulations. In terms of the quality of the 
civil  service  and  human  resource  management  the  framework  highlights  that  performance 
assessments,  measures  to  promote  integrity  in  the  civil  service  and  rules  governing  the 
recruitment  of  civil  servants  and  of  senior  managers  are  key  for  a  well  performing 
administration.  In  order  to  ensure  accountability,  providing  access  to  public  data  and  well-
functioning  oversight  institutions  and  a  fair  and  effective  system  of  administrative  review 

52 Commission Communication, COM(2018) 770 final, Annual Growth Survey 2019.  
53 OECD- SIGMA (2017), The Principles of Public Administration, OECD Publishing, Paris 
54  Guidelines  for  assessing  public  administration  and  governance  in  the  European  Semester,  September  2019, 

Note to the Economic Policy Committee. 

55  It  looks  into  five  performance  areas:  i)  policy  planning,  development  and  coordination;  ii)  civil  service  and 
human resource management, iii) accountability, iv) service delivery and v) public financial management. 

25 

 
 
 
 
                                                 
along with effective justice systems are essential. Top performant service delivery by public 
administrations is characterised by user centricity and the existence of mechanisms to ensure 
the quality and access of services.  

5.2 Product markets and the business environment 

Despite the progress achieved in product and services market regulations in the past two 
decades,  reforms  are  slowing  down.  Euro  area  Member  States  have  been  implementing 
competition-enhancing  product  market  regulation  at  a  steady  pace  since  the  introduction  of 
the  euro,  as  measured  by  the  OECD’s  product  market  regulation  indicators  which  show  a 
significant  reduction  in  the  restrictiveness  of  product  market  regulation  between  1998  and 
2013.56  Moreover,  the  European  Commission’s  assessment  of  the  implementation  of 
structural  reforms  recommendation in  the area of product  markets57 shows that, on average, 
Member  States  have  made  only  some  progress,  since  2013.  In  effect,  challenges  remain,  as 
almost  no  recommendations  in  the  area  of  product  and  services  markets  reforms  have  been 
fully implemented. Most have seen, on average, only limited implementation. Also, progress 
in the OECD indicators was much faster in the period 1998 to 2008 than between 2008 and 
2013. This might reflect the low hanging fruits of the initial sets of reforms, or some reform 
fatigue in member states.  

Graph 16: Difference in productivity between top 10% 
and median firms, euro area 

Graph 17: Productivity growth and allocative 
efficiency from 2005 to 2016, euro area 

55

50

45

40

35

30

25

1000 EUR/person employed 

C

F

G

H

I

J

M

N

99

01

03

05

07

09

11

13

15

-20

-10

0

10

20

30

40

Growth in allocative efficiency (%)
Within-firm productivity growth (%)

Source: COMPNET database and European Commission calculations 

Note: these are NACE sectors. 
Source: COMPNET database and European Commission calculations 

56 The most recent figures, for 2018, cannot be compared with previous vintages of the data but show that the 

differences among countries increased somewhat. 

57 This refers to the policy areas “competition in services” and “competition & regulatory framework” and to an 

average annual assessment for the period 2013-2018. 

26 

 
 
 
 
 
 
 
 
                                                 
Productivity  growth  across  advanced  economies  has  been  declining  in  the  last  few 
decades and the euro area is no exception. In addition, the gap in productivity between the 
most  productive  firms  and  all  the  rest  has  been  increasing,  including  in  the  euro  area.  58  
(Graphs 20 to 25). This weighs on productivity growth because it implies that technological 
diffusion from the frontier firms to the rest of the economy is not working properly. Resource 
misallocation seems to have also worked as a drag on productivity growth (Graph 17). Factors 
inhibiting  the  reallocation  of  resources  to  more  productive  firms,  are  a  barrier  to  aggregate 
productivity growth and decrease average productivity. Post-crisis employment gains in major 
euro area economies have been mainly in low productivity activities, dragging down overall 
productivity  (Box  4).  Increased  productivity  of  frontier  firms  compared  with  laggards  often 
goes hand in hand with higher mark-ups of top firms and lack of competition globally.59 But 
this phenomenon seems  to be much more pronounced in the US than in the EU thanks to a 
more  effective  competition  policy.60  Structural  reforms  play  a  role  in  improving  allocative 
efficiency and diffusion of innovation from frontier firms to laggards (Box 4). 

BOX 4: Productivity in the euro area: looking beyond aggregate trends. 

Graph 18: Total factor productivity growth 

Graph 19: Percentage of jobs created in sectors 
with above-median productivity 

4

3

2

1

0

-1

-2

EA 15
Average (US, CN, JP, SW, NO, UK)

3
6

8
6

3
7

8
7

3
8

8
8

3
9

8
9

3
0

8
0

3
1

8
1

45

40

35

30

25

20

15

10

5

0

2016 or latest available year

2006

T
L

I
F

E
E

V
L

I
S

E
B

U
L

E
D

R
F

E
I

T
I

K
S

L
N

T
A

L
E

T
P

S
E

Like  for  other  advanced  economies,  productivity  growth  in  the  euro  area  has  been 
decreasing in the last decades. Total factor productivity growth is now less than half of what 
it was during the sixties and since the economic and financial crisis it never went sustainably 
above  1%.  (Graph  18)  For  a  better  understanding  of  the  origin  of  such  a  slowdown  it  is 
important to look at more disaggregate data to see what is happening at firm level.  

58  Andrews,  D.,  Criscuolo,  C.  and  P.  Gal  (2016)  “The  best  versus  the  rest:  the  global  productivity  slowdown, 
divergence  across  firms  and  the  role  of  public  policy”,  OECD  Productivity  Working  Papers  November 
2016, No.5. 
59  Diez,  F,  F. 

Jiayue,  C.  Villegas-Sanchez 

competition’’,  Vox, 

‘’Global  declining 

(2019) 

https://voxeu.org/article/global-declining-competition  

60  Gutierrez,  G,  and  T  Philippon  (2018),  "How  EU  Markets  Became  More  Competitive  Than  US  Markets:  A 

Study of Institutional Drift", NBER working paper 24700. 

27 

 
 
 
                                                 
 
 
 
Graph 20: Labour productivity of the frontier 
firms and laggards - ES 

Graph 21: Labour productivity of the frontier 
firms and laggards - DE 

1000 EUR/person 
employed 

Bottom 10%
Median
Top 10%

1000 EUR/person 
employed 

Bottom 10%
Median
Top 10%

80

70

60

50

40

30

20

10

0

140

120

100

80

60

40

20

0

09

10

11

12

13

14

15

04 05 06 07 08 09 10 11 12 13 14

Graph 22: Labour productivity of the frontier 
firms and laggards - NL 

Graph 23: Labour productivity of the frontier 
firms and laggards - IT 

1000 EUR/person 
employed 

Bottom 10%
Median
Top 10%

120

100

80

60

40

20

0

1000 EUR/person 
employed 

Bottom 10%
Median
Top 10%

90

80

70

60

50

40

30

20

10

0

04 05 06 07 08 09 10 11 12 13 14

04 05 06 07 08 09 10

11 12 13 14

Graph 24: Labour productivity of the frontier 
firms and laggards - BE 

Graph 25: Labour productivity of the frontier 
firms and laggards - FR 

1000 EUR/person 

Bottom 10%
Median
Top 10%

120

100

80

60

40

20

0

1000 EUR/person 
employed 

Bottom 10%
Median
Top 10%

90

80

70

60

50

40

30

20

10

0

04 05 06 07 08 09 10 11 12 13 14

04 05 06 07 08 09 10 11 12 13 14

 Sources: (Graph 18) Ameco database 3-year rolling average. EA 15 are EA MS except EE, LV, LT and SK since for these MS figures are only available as 
of 1995; COMPNET. (Gaph 19)  OECD Structural and Demographic Business Statistics Database, 2018, figures for 2006 are not available for FR, LU, DE, 

28 

 
 
 
 
 
 
 
 
 
 
 
IE;  (Graphs 20, 21, 22, 23, 24, 25)  All MS:  labour productivity of  median  firms as  share of  labour productivity of top 10%  firms. Individual MS:  labour 
productivity of firms per decile. DE is 3-year rolling average. 

Splitting  the  firms  by  their  productivity  levels,  we  see  that  the  labour  productivity  of 
frontier  firms  seems  to  be  diverging  compared  with  laggards  (Graph  20  to  25).  The 
labour productivity of frontier firms, here represented by the top 10% of firms in each MS in 
terms  of  their  labour  productivity,  seems  to  be  increasing  in  most  euro  area  MS  and  in  the 
euro  area  as  a  whole.  The  labour  productivity  of  median  and  bottom  firms  seems  to  be 
decreasing or at least stabilising.  

Even  after  the  economic  and  financial  crisis  of  2008  the  productivity  of  median  and 
bottom firms seems not to have improved, or only very little (Graph 20 to 25). This could 
indicate  that  the  crisis  did  not  have  the  cleansing  effect  for  productivity-enhancing 
reallocation and firm-restructuring it is expected from recessions61. Also, most jobs created in 
the euro area were in sectors with below median productivity. 

In  fact,  between  2005  and  2016,  growth  in  allocative  efficiency  in  the  euro  area  was 
negative for most sectors apart from Manufacturing, Transport and Storage as well as 
Administrative and Support Services62. Productivity growth came mainly from within-firm 
productivity growth. Employment is concentrating in sectors with below average productivity 
(Graph 19). The top three sectors generating the largest net employment gains over the period 
2010 to 2016 had below average labour productivity, with restaurants, health and residential 
care activities featuring highly.63 In recent years, the percentage of jobs created by enterprise 
births in sectors with above-median productivity were much below 50%, ranging from 40% in 
to 11% (Graph 19) 

Reforms can contribute to close this gap between frontier firms and laggards. Engaging 
in  vocational  education  programmes  and  closing  the  training  gap  to  large  firms  must  be 
strengthened  in  order  to  increase  productivity  of  laggard  firms.  In  some  countries  factors 
including  weak  banks  and  inefficient  insolvency  frameworks  prevent  distressed  firms,  too 
weak  to  survive  in  a  competitive  market,  from  exiting  the  market.  Incentives  to  help  small 
rather than young firms can also be a drag on productivity as smaller mature firms tend to be 
less  productive  than  large  ones  but  new  small  firms  are  often  found  to  spur  aggregate 
productivity growth as they enter with new technologies and stimulate productivity-enhancing 
changes by incumbents. 

As product and services market reforms can have a positive impact on potential growth, 
incentivising  these  reforms  remains  essential.  Improving  the  regulatory  environment  for 
innovation,  competition  and 
product  and  service  markets  can  contribute 
productivity64, essential to boost potential growth. There are potential synergies for increasing 
resilience  in  the  euro  area  from  an  EU-coordinated  push  for  reforms,  including  legislative 
action at EU level. This could contribute to speed up reform pace which has slowed down, but 
would not replace much needed action at Member State level.   

to  more 

Facilitating  the  adoption  and  diffusion  of  digital  structural  reforms  can  improve 
economic resilience, growth potential and relative convergence. Initial conditions in terms 

61 Bartelsman et al. (2017). 
62 COMPNET. European Commission calculations. 
63 OECD (2018), OECD Compendium of Productivity Indicators 2018, OECD Publishing, Paris. 
64  Égert,  B.  (2016),  “Regulation,  institutions  and  productivity:  new  macroeconomic  evidence  from  OECD 

countries”, American Economic Review Papers and Proceedings, 106(5), 109-113. 

29 

 
 
 
                                                 
of digital  infrastructure and skills  vary  greatly  across euro area Member States. Most of the 
differentiation  is  in  terms  of  human  capital  and  integration  of  digital  technology,  while  the 
ranking  is  more  comparable  in  dimensions  such  as  connectivity,  digital  public  services  and 
use  of  the  internet.65  This  may  worsen  the  relative  comparative  advantages  within  the  euro 
area  if  it  is  not  accompanied  by  adequate  structural  reforms  and  investments66.  In  labour 
markets,  the  digital  revolution  could  have  an  impact  on  employment  composition,  work 
organisation,  wage  setting  and  contract  types  creating  risks  of  increased  labour  market 
polarisation,  skills  mismatch  and  a  higher  structural  unemployment  triggered  by  the  skills-
biased  nature  of  digital  technologies.67  In  financial  markets,  the  increased  role  of  data  and 
technology  requires  constant  regulatory  upgrading  and  increased  vigilance  by  supervisors. 
Reforms  to  face  all  these  challenges  include  in  addition  to  strengthening  the  regulatory 
framework,  completing  the  Digital  Single  Market,  investing  in  digital  infrastructure  and 
increase training in digital skills. 

Single Market integration has slowed down, and there remain barriers for firms to grow 
and  investment  in  the  euro  area.  Though  good  progress  has  been  achieved  in  the 
transposition  of  Single  Market  directives  over  the  last  20  years,  as  shown  by  a  significant 
decrease  of  the  average  transposition  deficit  (from  6.3%  in  1997  to  0.9%  in  2017),  recent 
transposition rates have been weaker (25% transposition rate in June 2018 for 16 Directives 
adopted  between  2016  and  2017)  and  infringement  procedures  had  to  be  launched  by  the 
Commission  against  21  Member  States  in  2016,  3  of  which  are  still  ongoing68.  Moreover, 
although  the  overall  convergence  of  price  levels  has  broadly  resumed  since  2014,  it  is  now 
slower  compared  to  the  speed  observed  since  the  creation  of  the  euro.  New  integration 
frontiers are in areas such as services which would provide a significant boost to productivity 
and  growth,  and  taxation  where  divergences  of  applicable  rules  are  perceived  by  many 
businesses as a major obstacle in the Single Market. The same applies to the social dimension 
of  the  Single  Market  where  progress  is  essential  to  allow  all  citizens  to  benefit  fully  from 
integration.69 

Ensuring  a  well-integrated  market  for  network  industries  can  increase  the  capacity  to 
withstand and recover from shocks as they supply general purpose goods and services. 
Secure supply from network industries at a correct pricing is key to absorb and recover from a 
shock as they are an underpinning of economic activity. However, progress in implementing 
CSRs  from  2013  to  2018  on  network  industries  as  well  as  competition  and  regulatory 
framework  (average  annual  assessment  of  the  Structural  Policies  area)  was  low  compared 
with  other  areas.  Heterogeneity  in  cross-border  regulation  resulting  in  fragmented  markets 
may weaken the effectiveness of common macro-economic policies and hence the resilience 
of economies. Also, quality and cost of products and services provided by network industries 
have  an  important  economic  impact  as  they  are  key  production  components  of  most 
industries, thus vitally contributing to the recovery from shocks. Further integrating networks 

65 Digital Economy and Society Index, European Commission Digital Scoreboard 2019. 
66 “The macro-economic implications of the digital economy” (2018), QREA vol 17, 2  
67 Petropolus (2019), “Digitalisation and European welfare states”, Bruegel, Blueprint series 30. 
68 Commission Communication, COM(2018) 772 final, ‘The Single Market in a changing world’. 
69 Ibid. 

30 

 
 
                                                 
across the EU is therefore essential to foster more flexible prices and production in key areas 
such as energy, transport, telecommunication and digital infrastructure. The situation in most 
euro area Member States for which data are available, shows that product market regulation in 
network industries decreased between 2000 and 201370. Barriers nonetheless remain and they 
are typically identified as referring to entry, ownership, degree of vertical integration, market 
structure as well as political economy dynamics.71 

Industry plays a vital role for prosperity and sustaining our social model. Currently, an 
industrial  transformation  is  taking  place,  with  an  increasing  role  of  digitalisation,  the 
transition to a climate-neutral and circular economy and a fast-changing geopolitical context. 
A still fragmented Single Market and fragmented policies are barriers for European firms to 
scale up and to get the economy ready for the realities of the 21st century digital age and the 
challenges  posed  by  the  climate  emergency.   In  order  to  respond  to  these  challenges,  as  a 
follow-up to the EU industrial policy strategy, the Strategic Forum for Important Projects of 
Common  European  Interest  recommends  more  pooling  of  resources  and  more  coordinated 
action  among  Member  States  and  coordinated  investments  along  strategic  industrial  value 
chains.  

5.3 Labour market and social protection systems  

Labour  market  indicators  have  continued  improving  steadily,  despite  a  deteriorating 
macroeconomic  outlook.  Unemployment  and  youth  unemployment  rates  have  been  ebbing 
and  have  reached  7.5%  and    15.8%  respectively  in  Q3  2019  and  long-term  unemployment  
reached 3.3% in Q2 2019 (Graphs 26 and 27). Unemployment is forecast to decline further to 
7.3%  in  2021,  more  than  1  percentage  point  below  pre-crisis  levels,  though  the  decline  is 
decelerating. Total employment continued to grow by 1% in 2019 and is set to continue, albeit 
more slowly, at around ½% in 2020 and 2021. Divergences in labour market indicators remain 
wide  in  the  euro  area:  in  2018,  the  unemployment  rate  ranged  from  3.4%  in  Germany  to 
19.3% in Greece. 

However,  challenges  in  terms  of  job  quality  and  in-work  poverty  remain,  particularly 
among  less-qualified  workers.  Involuntary  part-time  work72  and  temporary  employment 
have  not  seen  a  significant  improvement  over  the  past  years,  pointing  to  slower  growth  in 
quality employment (Graph 28). Involuntary part-time work as a percentage of total part-time 
employment has been on a decreasing trend since 2014 but is still 3 percentage points above 
its pre-crisis levels, while workers on temporary contracts have been increasing steadily from 
12.7%  in  2012  to  13.9%  in  2018.  At  the  same  time,  the  in-work-at-risk-of-poverty  rate  has 
been  steadily  increasing  from  8.1%  in  2008  to  9.5%  in  2016,  to  recede  only  marginally  to 
9.3% in 2018 (Graph 29). Moreover, the risk of poverty remains much higher among workers 
with  a  temporary  job  at  17.2%  and  part-time  workers  at  14%.  The  total  number  of  hours 

70 European Commission (2013), Market Functioning in Network industries. 
71 QREA, Vol. 17, No. 1 (2018). 
72  Measured  as  under-employed  workers,  i.e.,  workers  whose  main  job  is  part-time  and  who  report  either  that 

they could not find a full-time job or that they would like to work more hours. 

31 

 
 
 
                                                 
worked  has  also  been  slow  to  recover  to  its  pre-crisis  levels  and,  contrary  to  the  EU  as  a 
whole, in 2018 was still 1% below its level in 2008 (Graph 30). 

The  materialisation  of  risks  would  negatively  impact  labour  market  developments, 
especially for more vulnerable Member States. While labour market indicators for the euro 
area  have  remained  positive  despite  the  deterioration  of  broader  economic  indicators,  for 
some  Member  States,  the  unemployment  rate  is  still  significantly  above  10%.  In  2018,  the 
proportion  of  temporary  contracts  ranged  from  1.4%  to  22.7%  of  total  employment. 
Moreover,  rates  of  involuntary  temporary  employment  ranged  from  0.9%  to  21.3%  of  total 
employment  in  the  same  year.  Differences  are  also  large  in  terms  of  part-time  contracts, 
ranging  from  4.9%  of  total  employment  to  50.1%,  as  well  as  in  the  proportion  o  that  is 
involuntary, from 5.8% to 70.1%.  

Graph 26: Youth unemployment and long-term 
unemployment, euro area 

Graph 27: Youth unemployment, June 2019 

60

50

40

30

20

10

0

20

18

16

14

12

10

8

6

4

2

0

% labour force 

2018

2013

2008

E
D

L
N

I
S

T
M

T
A

T
L

E
E

V
L

U
L

E
I

K
S

E
B

A
E

I
F

Y
C

T
P

R
F

T
I

S
E

L
E

Graph 29: In-work at-risk-of-poverty rate 

% employed persons 

2018
2013
2008

U
L

S
E

T
I

L
E

T
P

A
E

E
E

E
D

V
L

T
L

T
A

Y
C

R
F

T
M

K
S

I
S

L
N

E
B

E
I

I
F

28

24

20

16

12

8

4

0

% labour force 

Youth unemployment (lhs)
Long-term unemployment (rhs)

07 08 09 10 11 12 13 14 15 16 17 18

Graph 28: Part-time and temporary work, euro 
area 

24,0

22,0

20,0

18,0

16,0

14,0

12,0

10,0

% total employment 15-64y 

% part-time 
employment 

Part-time employment (lhs)
Temporary employment (lhs)
Involuntary part-time employment (rhs)

07 08 09 10 11 12 13 14 15 16 17 18

40

36

32

28

24

20

32 

 
 
 
 
 
 
 
 
 
 
 
Graph 30: Employment and hours worked, euro 
area 

Graph 31: Participation in education and training 
(last 4 weeks), euro area 

2010 = 10 

106

104

102

100

98

96

94

92

Hours worked per employed person
Total employment domestic concept
Thousand hours worked

% population 
18-64y 

22

20

18

16

14

12

10

High skilled
Medium skilled
Low skilled

05 06 07 08 09 10 11 12 13 14 15 16 17 18

13

14

15

16

17

18

Source: Eurostat 

While wage growth has accelerated in 2018, it is  unclear whether this dynamic will be 
sustained. Nominal wage growth  had remained subdued in  the past  years but  has started to 
accelerate  registering  year-on-year  growth  of  2.6%  in  2019,  and  is  projected  to  continue  at 
2.3% in 2019 and 2020. However, though wage increases are set to continue on the back of 
ongoing  wage  settlements,  real  wage  growth  is  expected  to  remain  low  after  an  increase  of 
1%  in  2019  at  0.7%  and  0.8%  in  2020  and  2021,  despite  slow  inflation.  Unit  labour  cost 
dynamics in  the post-crisis  period have contributed to  reducing external  imbalances,  as net-
debtor  countries  benefited  from  stronger  cost  competitiveness  gains  as  compared  with  net-
creditor  countries.  More  recently,  the  advantage  of  net-debtor  countries  in  terms  of  cost 
competitiveness dynamics has slowed in comparative terms due to tightening labour markets 
and a reduced pace of productivity improvements.73   

While technological change and the digital revolution create new job opportunities, they 
also raise challenges related to the loss of low-skill jobs and the increase in non-standard 
work. In this context, investment in skills is key to ensure that all citizens reap the benefits of 
technological transformation. Population ageing and rising old-age dependency ratios further 
reinforce  the  need  for  adequate  and  efficient  investment  in  human  capital.  Significant 
differences across euro area Member States persist in terms of the share of early leavers from 
education  and  training  and  participation  rates  in  adult  learning,  which  has  been  recovering 
slowly.74  Reducing  labour  market  segmentation  has  positive  effects  in  terms  of  higher 
investment  in  human  capital  as,  employers  tend  to  invest  less  in  upgrading  the  skills  and 
competencies  of  temporary  employees.  In  turn,  this  may  translate  into  higher  productivity, 
stronger resilience and long-term growth. 

On the back of the labour market recovery, poverty and social exclusion are declining in 
virtually  all  Member  States.  However,  poverty  and  inequalities  are  still  above  pre-crisis 

73 European Commission (2018), Alert Mechanism Report 2019. 
74  For  more  details  see  DG  Employment  (2018),  'Chapter  1:  Main  Employment  and  Social  Developments',  in 

Employment and Social Developments in Europe 2018 Report. 

33 

 
 
                                                 
 
 
levels  in  several  countries.  In  2018,  the  number  of  people  at  risk  of  poverty  and  social 
exclusion  was  still  one  million,  above  the  2008  level.  Moreover,  some  categories,  such  as 
children, people with a migrant background and temporary workers, face persistently higher 
risks of poverty. As unemployment and social inequalities are seen by Europeans as the two 
main challenges  looking ahead [Eurobarometer 467/2017], an increasing  number of citizens 
express  a  sense  of  vulnerability.  Drivers  of  this  feeling  include  income  inequality  having 
increasing 
limited 
stabilised  at  historically  high 
precariousness  in  labour  market  relations,  and  the  uneven  impact  of  globalisation  and 
technological  change  on  citizens’  life.  Social  protection  systems  are  being  adapted  in  many 
Member  States,  but  challenges  persist  in  protecting  all  those  in  need,  irrespective  of  their 
working status. Tax and benefit systems also play a key role in reducing inequalities: in the 
euro  area,  the  impact  of  social  transfers  (excluding  pensions)  on  poverty  reduction  remains 
high at 32%, though decreasing over time.   

intergenerational  mobility, 

levels, 

To  address  the  challenges  facing  labour  markets  and  their  social  and  economic 
implications, national reforms should implement the principles of the European Pillar of 
Social  Right.  The  Pillar  aims  at  delivering  effective  rights  for  citizens  in  terms  of  equal 
opportunities  and  access  to  the  labour  market,  fair  working  conditions  as  well  as  social 
protection  and  inclusion.  Such  reforms  would  help  to  strengthen  inclusive  growth  and 
resilience across the euro area75. Reforms at national level should promote quality job creation 
and reduce labour market segmentation and structural unemployment while promoting social 
cohesion. Key elements of such reforms include (i) high-quality, efficient and inclusive life-
long  education  and  training  systems  in  combination  with  well-designed  skills  anticipation 
strategies  that  aim  at  better  matching  skills  with  labour  market  needs;  (ii)  employment 
legislation  that  provides  fair  working  conditions  for  all  workers,  as  well  as  flexibility  and 
security  for  employees  and  employers;  (iii)  effective  active  labour  market  policies  that 
support  labour  market  transitions;  (iv)  sustainable  and  adequate  social  protection  systems.  
The  latter  –  which  should  be  adapted  to  cover  all  workers  as  new  forms  of  work  emerge  - 
provide automatic stabilization during economic downturns, support labour reallocation, and 
pave  the  way  for  higher  living  standards  in  the  longer  term.  Adequate  social  protection 
systems, together with the portability of social rights and pension entitlements, promote a fair 
labour mobility, which also improves the resilience of the euro area. EU-level reforms, some 
currently  under  consideration,  would  also  help  ensure  adequate  social  protection,  inclusion 
and fair working conditions. 

5.4. Financial markets and completing the Banking Union and Capital Markets Union 

Risk reduction in the banking sector broadly continued in 2019. Banking sectors in nearly 
all Member States  continued to  increase the quantity  and quality of their capital  and reduce 
their  leverage.  While  the  loan-to-deposit  ratio  has  increased  again  by  3  percentage  points 
between  Q1  2018  and  Q1  2019,  back  to  around  the  levels  of  2015-2016  (Graph  32),  the 

75 The Social Pillar sets out 20 key principles and rights to support fair and well-functioning labour markets and 

welfare systems. For more details see http://ec.europa.eu/social/main.jsp?catId=1226&langId=en  

34 

 
 
 
                                                 
liquidity coverage ratio has continued its upward trend, from 142% in Q1 2017 to 147% in Q2 
201976. Non-performing loans (NPLs) declined to 3.4% of total loans in Q2 2019 in the euro 
area, compared to 4.2% a year earlier, with the faster correction observed in Member States 
with the highest stock of such loans. Some national NPL ratios still remain far apart from the 
euro area average and continue to require attention (Graph 33) but these are exceptions from 
the  large  majority  of  Member  States.  At  the  same  time,  while  households  have  seen  their 
liabilities  decrease  from  69%  of  GDP  in  2010  to  below  61%  in  2018,  non-financial 
corporations have been increasing their debt from 203% of GDP in 2010 to 233% in 2017 and 
have only started deleveraging to 222% of GDP in 2018. 

Graph 32: Bank stability indicators 

Graph 33: Non-performing loans

20

% 

18

16

14

12

10

% 

102

100

98

96

94

92

90

88

CET 1 ratio (lhs)
Leverage ratio (lhs)
Loan-to-deposit ratio (rhs)

4
Q
4
1

2
Q
5
1

4
Q
5
1

2
Q
6
1

4
Q
6
1

2
Q
7
1

4
Q
7
1

2
Q
8
1

4
Q
8
1

2
Q
9
1

50

45

40

35

30

25

20

15

10

5

0

% of loans and 
advances 

2016Q2

2019Q2

L
E

Y
C

T
P

T
I

V
L

I
S

E
I

S
E

T
M

K
S

R
F

T
A

T
L

E
B

L
N

E
E

I
F

E
D

U
L

 Note:  Euro  area  changing  composition,  unless  otherwise  indicated.  Domestic  banking  groups  and  stand-alone  banks,  foreign  (EU  and  non-EU)  controlled 
subsidiaries and foreign (EU and non-EU) controlled branches, All institutions. 
Source: ECB - CBD2 - Consolidated Banking data. 

Additional  measures  have  been  put  in  place  to  further  strengthen  banks’  resilience, 
integration  and  financial  sector  integrity.  Following  a  request  from  the  Council,  the 
Commission  published  a  dedicated  package  of  legislative  and  other  measures  to  address 
legacy  NPLs  and  avoid  their  build-up  in  the  future,  with  actions  at  euro  area  and  national 
level.77 As part of the legislative measures on NPLs, a regulation was adopted in April 2019,78 
which  introduces  a  ‘statutory  prudential  backstop’  in  order  to  prevent  the  risk  of  under-
provisioning  of  future  NPLs.  There  has  also  been  some  progress  in  the  negotiations  on  the 
Commission proposal for a directive that would enable banks to deal in a more efficient way 
with loans once they become non-performing by improving conditions to either: (1) sell the 
credit to third parties on a secondary market; or (2) enforce the collateral used to secure  the 
credit. The recent adoption, in the Spring of 2019, of the November 2016 Banking Package, 
which further reduces risks by implementing internationally-agreed norms on loss absorbing 

76 In EU countries participating in the Single Supervisory Mechanism. 
77 European Commission, ‘Reducing risk in the Banking Union: Commission presents measures to accelerate the 
reduction of non-performing loans in the banking sector’, 2019,  http://europa.eu/rapid/press-release_IP-18-
1802_en.htm?locale=en  

78  Regulation (EU)  2019/630 of  the  European  Parliament  and  of  the  Council of  17  April  2019  amending 

Regulation (EU) No 575/2013 as regards minimum loss coverage for non-performing exposures. 

35 

 
 
 
                                                 
 
 
capacity,  on  capital  requirements  and  liquidity  requirements  for  banks,  was  a  crucial  step 
towards the completion of the Banking Union. The banking package also reinforced the anti-
money  laundering  dimension  in  prudential  supervision  and  the  cooperation  obligations 
between  the  various  authorities  in  relation  to  anti-money  laundering.  As  highlighted  in  the 
Commission reports on anti-money laundering issued in July 201979, a more comprehensive 
approach to fighting money laundering and the financing of terrorist activities is needed in the 
EU  to  address  structural  shortcomings  identified.  Separately  from  the  banking  package, 
measures  have  already  been  adopted  to  reinforce  the  European  Banking  Authority  and 
supervisory  cooperation  and  to  address  some  of  the  shortcomings  in  the  anti-money 
laundering framework as unveiled by several recent events.80 Going forward, the Commission 
will  further  explore  whether  certain  supervisory  powers  and  responsibilities  might  be  better 
allocated  to  a  Union  body  and  the  possibility  of  creating  a  coordination  and  support 
mechanism to facilitate cross-border cooperation and exchanges among financial intelligence 
units.  Moreover,  the  work  of  the  Single  Supervisory  Mechanism  and  the  Single  Resolution 
Board  also  contributes  to  reducing  risks  by  increasing  the  preparedness  for  orderly  bank 
resolution and setting the targets for increasing loss absorption. Overall, the EU has adopted 
more than fifty legislative proposals since the crisis to increase the resilience of the financial 
sector. 

However, other important areas remain to be completed, including notably the backstop 
to  the  Single  Resolution  Fund  and  a  European  Deposit  Insurance  Scheme  (EDIS).  In 
June  2018,  the  EU  Heads  of  State  and  Government  agreed  that  the  backstop  to  the  Single 
Resolution Fund will be provided by the European Stability Mechanism and that work should 
start on a roadmap for political negotiations on EDIS. Work has progressed on the backstop to 
the  Single  Resolution  Fund  and  the  Euro  Summit  of  June  2019  mandated  the  Eurogroup  to 
work  towards  an  agreement  in  December  2019.    Ambitious,  even  if  gradual,  progress  is 
necessary for EDIS in light of its key stabilising properties and its importance for promoting 
financial integration. Achieving a financial union is crucial to ensure stability. 

Bank  profitability  did  not  improve  in  2017-2018,  as  the  sector  continues  to  face 
challenges  from  the  economic  environment  and  business-model  transformation. 
Profitability remains  low, below banks’  estimated long-run  cost  of equity  and though it has 
been  recovering  overall  since  the  low  of  2012  amidst  improved  asset  quality  and  market 
conditions,  return  on  equity  stagnated  in  the  following  year.  Some  national  banking  sectors 
still post  very low or even negative return on equity  given tight  interest  margins,  remaining 
legacy  assets,  market  fragmentation  and  operational  inefficiencies  (Graphs  34  and  35).  A 
number of challenges lie on the horizon, including considerable fragmentation across the euro 
area  market,  low  yields  and  competition  from  fin-tech  firms.  Though  several  price-based 
banking  market  indicators  show  convergence  has  resumed,  the  level  of  integration  remains 

79  Commission  Communication,  COM(2019)  360  final,  from  the  Commission  to  the  European  Parliament  and 
the  Council  of  24  July  2019  towards  better  implementation  of  the  EU's  anti-money  laundering  and 
countering the financing of terrorism framework. 

80  Commission Communication, COM(2019) 373 final, from the Commission to the European Parliament and 
the Council of 24 July 2019 on the assessment of recent alleged money laundering cases involving EU credit 
institutions. 

36 

 
 
                                                 
low, and the continued fragmentation of retail banking markets limits the ability of the sector 
to  respond  to  profitability  challenges  and  finance  the  investments  needed  to  adapt  to  a 
changing  competitive  landscape  and  innovation.  This  is  another  reason  to  progress  faster  in 
the completion of the Banking Union.81 

Graph 34:  Banks’ return on equity*, euro area 

Graph 35: Banks’ return on equity*, euro area 

Estimated long-run cost of equity 

% 

10

8

6

4

2

0

-2

-4

7
0

8
0

9
0

0
1

1
1

2
1

3
1

4
1

5
1

6
1

7
1

8
1

20

15

10

5

0

-5

-10

-15

2018

2017

Estimated long-run cost of equity 

T
L

I
S

E
E

E
B

T
A

L
N

S
E

Y
C

I
F

E
I

R
F

K
S

T
M

U
L

T
I

A
E

V
L

E
D

L
E

T
P

Graph 36: Credit to the private non-financial 
sector**, euro area 

120

% GDP 

% GDP 

180

Graph 37: Variation across euro area Member 
States in MFI*** interest rates for non-financial 
corporations 

110

100

90

80

Banks (lhs)
All sectors (rhs)

1
Q
-
3
0

1
Q
-
5
0

1
Q
-
7
0

1
Q
-
9
0

1
Q
-
1
1

1
Q
-
3
1

1
Q
-
5
1

1
Q
-
7
1

1
Q
-
9
1

170

160

150

140

130

8

7

6

5

4

3

2

1

0

Maximum

Median

Minimum

n
a
J
-
3
0

v
o
N
-
3
0

p
e
S
-
4
0

l

u
J
-
5
0

y
a
M
-
6
0

r
a
M
-
7
0

n
a
J
-
8
0

v
o
N
-
8
0

p
e
S
-
9
0

l

u
J
-
0
1

y
a
M
-
1
1

r
a
M
-
2
1

n
a
J
-
3
1

v
o
N
-
3
1

p
e
S
-
4
1

l

u
J
-
5
1

y
a
M
-
6
1

r
a
M
-
7
1

n
a
J
-
8
1

v
o
N
-
8
1

p
e
S
-
9
1

*Domestic banking groups and stand-alone banks. 
**Stocks of total credit, adjusted for breaks. 
***According to the ECB, "Monetary financial institutions" (MFIs) are resident credit institutions as defined in European Union law, and other resident financial 
institutions  whose  business  is  to  receive  deposits  and/or  close  substitutes  for  deposits  from  entities  other  than  MFIs  and,  for  their  own  account  (at  least  in 
economic terms), to grant credits and/or make investments in securities. 
Sources: (Graohs 34, 35 and 37) ECB, (Graph 36) BIS. 

Though  starting  from  a  low  level,  the  share  of  non-bank  finance  in  the  euro  area’s 
financial system has continued to grow, creating a more diverse mix of funding sources. 
While total credit has seen an overall increasing trend, the stock of bank lending to the private 
non-financial  sector  relative  to  GDP  has  been  on  a  steady  downward  trend  since  the  crisis 

81 "Financial integration in Europe", ECB 2018. 

37 

 
 
 
 
 
                                                 
 
 
 
 
  
 
Though, (Graph 36). Capital markets are gradually becoming more prominent in the euro area 
in  line  with  policy  goals,  which  calls  for  additional  efforts  to  strengthen  supervisory 
capabilities  and  fill  data  gaps  to  monitor  and  appraise  risks.82  However,  Bank  lending  still 
accounts  for  a  high  share  of  total  financing  for  non-financial  corporations  in  the  euro  area, 
accounting for 55% of total credit as opposed to 34% in the United-States. And in 2018 the 
share  of  non-financial  corporations’  funding  raised  in  capital  markets  declined  compared  to 
the period 2013-201783. Also, the role of equity financing remains low. These developments 
show that there is still much to be done to further develop capital markets in Europe. 

Borrowing costs remain uneven across the euro area. The capital flight from periphery to 
core  Member  States  during  the  crisis  period  exacerbated  divergences  and  resulted  in  large 
differences  in  borrowing  costs  between  Member  States  which  started  to  decrease  in  2014, 
though  they  are  still  evident  (Graph  37).  Even  excluding  Member  States  with  the  highest 
interest rates, there is evidence that spreads widened during shocks, and it is not clear whether 
the  euro  area’s  vulnerability  to  future  shocks  through  this  channel  has  been  reduced.  To 
support  investment  financing  for  the  corporate  sector  across  the  whole  euro  area,  and  in 
particular  for  SMEs  that  are  reliant  on  bank  financing,  policies  to  reduce  financial 
fragmentation, accelerate banking sector restructuring and shift the euro area economy further 
from  bank  financing  towards  other  types  of  financing,  notably  from  capital  markets,  are 
warranted. 

The Commission delivered on all of the actions announced in the Capital Markets Union 
(CMU)  action  plan.  However,  important  barriers  remain,  including  regulatory,  legal 
and  tax  divergences  that  need  to  be  more  decisively  addressed.  Deeper  and  more 
integrated  capital  markets  create  better  funding  opportunities  for  companies  to  support 
investments at lower costs. They are also essential for making the euro area more resilient to 
the 
economic  shocks 
Commission’s CMU action plan, as reinforced by its mid-term review, progressed further in 
2018  and  2019  in  several  important  areas.84  The  majority  of  the  Commission  proposals  (11 
out of 13) have been adopted or politically agreed. However, advancing in the harmonisation 
of insolvencyand tax proceedings – including by applying the code of conduct on withholding 
taxes  to  simplify  procedure  for  compliant  investors  –  are  also  necessary  steps  to  build  a 
genuine CMU. 

through  private  sector  risk  sharing.  The 

implementation  of 

The  Commission’s  work  on  sustainable  finance  has  made  significant  progress.  Key 
measures  of  the  Action  Plan  on  financing  sustainable  growth85  adopted  in  March  2018  are 
being  implemented.  Proposals  on  disclosures  of  the  financial  sector  related  to  sustainability 
investments and sustainability risks and EU climate benchmarks have been adopted. The co-
legislators have reached  a common understanding on the proposal  for the EU taxonomy  for 
environmentally  sustainable  economic  activities;  Furthermore,  against  the  background  of 

82 European financial stability and integration review (EFSIR), European Commission SWD (2018). 
83 AFME, Capital Markets Union: Key performance indicators, October 2019. 
84  Investment  funds,  pension  funds,  venture  capital,  access  to  public  markets,  crowdfunding,  covered  bonds, 

securitisation, investment firms and supervision. 

85 Commission Communication, COM(2018) 97 final, Action plan on financing sustainable growth. 

38 

 
 
                                                 
global green bond issuance increasing to EUR 140bn in 2018 and representing more than 2% 
of  global  bond  issuances  in  the  last  two  years,  preparatory  work  on  an  EU  Green  Bond 
Standard has been undertaken86. In light of substantial investment needs over the next decade 
(up  to  EUR  290  billion  in  low-carbon  energy,  transport  and  infrastructure)  to  reach  the 
European  Union’s  climate  and  energy  goals  as  well  as  international  climate  change  targets, 
the  Commission  is  elaborating  its  green  financing  strategy,  as  part  of  the  “European  Green 
Deal”  priority  of  the  next  Commission.  As  the  financial  sector  has  significant  exposures  to 
fossil fuel and other climate-related sectors87, work is progressing by financial institutions as 
well as regulatory authorities to more closely monitor and evaluate corresponding risks. 

6. Deepening the Economic and Monetary Union 

Progress on deepening the EMU has been slow since the Commission Communication of 
December  201788.  In  a  Communication  from  June  201989  the  European  Commission  took 
stock  of  progress  made  to  deepen  the  EMU.  Ongoing  work  focuses  on  reforms  agreed  by 
leaders at the December 2018 Eurosummit, including ESM Treaty reform and improvement 
of the ESM toolkit (introduction of the common backstop and revision of the precautionary 
financial  instruments)  and  the  creation  of  a  budgetary  instrument  for  convergence  and 
competitiveness.  On  the  Financial  Union,  discussions  are  ongoing  for  an  agreement  on  the 
common backstop for the Single Resolution Fund and risk-reduction measures included in the 
banking  package  for  the  financial  sector.  Overall  progress  is  limited  on  other  reforms 
including on establishing  a European Deposit  Insurance Scheme. The beginning of political 
negotiations  on  EDIS  is  being  deferred.  After  the  foundation  of  the  CMU  has  been  laid, 
further work is needed to complete it, including finalisation of the legislative process on the 
three CMU proposals that are still in discussions with the Parliament and Council. Moreover, 
there has been no agreement towards a fiscal stabilisation function or on euro area governance 
proposals.  

There  has  been  some  progress  on  the  economic  union,  with  political  agreement  on  a 
budgetary instrument for convergence and competitiveness, and a Commission proposal 
to  set  a  Structural  Reform  Support  Programme.  Together  they  would  increase  financial 
incentives  to  the  implementation  of  structural  reforms  and  investment  as  well  as  greater 
technical assistance. The CSRs already indicate the key areas for investment in each Member 
State.  The  BICC  will  further  provide  strategic  guidance  linking  priority  investments  at 
national level with the priorities for the euro area.  

86  Technical  Expert  Group  (TEG)  on  sustainable  finance;  https://ec.europa.eu/info/publications/sustainable-

finance-teg-green-bond-standard_en 

87 See e.g. Weyzig et al. (2014) The price of doing too little too late, Green European Foundation, ESRB (2016) 
Too late, too sudden: Transition to a low-carbon economy and systemic risk, Dietz et al. (2016) ‘Climate value 
at risk’ of global financial assets, Nature Climate Change, Battiston et al. (2017). A Climate stress-test of the 
EU financial system, Nature Climate Change,  

88  Commission  Communication,  COM(2017)  821  final,  Further  steps  towards  completing  Europe’s  economic 

and monetary union: a roadmap. 

89  Commission  Communication,  COM(2019)  279  final,  Deepening  Europe’s  economic  and  monetary  union: 

taking stock four years after the Five Presidents’ Report. 

39 

 
 
 
                                                 
The EMU reform agenda needs to be pursued in an ambitious manner. Strengthening the 
EMU, by completing the Banking Union and Capital Markets Union, is key for mobilising the 
necessary capital to foster the transition towards a sustainable economy and for fostering the 
international role of the euro to increase Europe’s ability to project its interests in the world. 
This  calls  for  a  resilient  and  deep  financial  system  and  an  increase  in  the  available  pool  of 
euro denominated assets with a high credit rating. Strengthening the external representation of 
the  euro  area  in  international  fora  would  also  help  to  foster  Europe’s  clout  in  the  global 
economy.  With  the  work  on  a  proposal  for  a  Budgetary  Instrument  for  Convergence  and 
Competitiveness  (BICC)  and  discussions  on  a  possible  European  Unemployment  Benefit 
Reinsurance  Scheme  (see  section  3),  the  Commission  aims  to  reinforce  the  competitiveness 
and the resilience of the euro area economy. The lack of a central fiscal stabilisation function 
significantly  weakens  the  euro  area’s  counter-cyclical  fiscal  capacity.  In  addition,  the 
Commission  will  issue  its  review  of  the  framework  for  economic  and  fiscal  surveillance, 
focusing  on  the  six-  and  the  two-pack,  in  the  beginning  of  2020,  opening  up  the  debate  on 
possible  ways  to  improve  it.  Going  forward,  it  would  also  be  important  to  integrate  the 
intergovernmental agreements into Union law and under the European Parliament’s oversight.  

40